FINA 353 Principles of Macroeconomics Lecture 5 Topic: ECONOMIC GROWTH HBC608HBC608 ECON582 HBC608 FINA 353 Principles of Macroeconomics Lecture 5 Topic: ECONOMIC GROWTH College of Business – Rabigh Dr. Mazharul Islam Finance NotesFinance notes Finance notes 1

After studying these topics you should be able to: HBC608HBC608 HBC608 ECON582 Lesson Objectives To learn about After studying these topics you should be able to: Define and calculate the economic growth rate and explain the implications of sustained growth. Describe the economic growth trend. Explain how population growth and labour productivity growth make potential GDP grow. Explain and measure of the sources of labour productivity of growth. Explain the policies designed to increase economic growth. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 2

Economic Growth HBC608HBC608 ECON582 HBC608 Economic Growth: It is a sustained expansion of production possibilities. It is not a temporary cyclical expansion and it is different from the rise in income. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 3

Economic Growth Dr. Mazharul Islam HBC608 HBC608HBC608 Economic Growth When resources are employed efficiently, CI in each of the panels shows the possible combinations of consumer goods and capital goods that can be produced in a given year. Points C and I depict the quantity of consumer and capital goods produced if all resources are used to produce that good, respectively. Positive Economic growth is an outward shift of the PPF in each of the two panels. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 4

Calculating Growth Rates ECON582 HBC608 HBC608HBC608 Calculating Growth Rates The Economic Growth Rate refers the change in real GDP between two years. Example: If real GDP in the current year is $ 8.4 trillion and real GDP in the previous year was $ 8.0 trillion then Growth Rate of Real GDP = $ 8.4 trillion - $ 8.0 trillion x 100 = 5% $ 8.0 trillion . Dr. Mazharul Islam Finance notes Finance NotesFinance notes 5

Sources of Economic Growth HBC608HBC608 Sources of Economic Growth HBC608 Working age Population Labor force participation Average hours per worker Quantity of labor Total Output (Real GDP) Labor productivity Physical capital Human capital Education and training Job experience Technology Dr. Mazharul Islam Finance notes Finance NotesFinance notes 6

HBC608HBC608 ECON582 HBC608 Productivity Productivity measures how efficiently resources are employed. The higher the productivity, the more goods and services that can be produced from a given amount of resources  defined as the ratio of total output divided by the amount of a particular kind of resource employed. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 7

Productivity Dr. Mazharul Islam HBC608HBC608 ECON582 HBC608   Dr. Mazharul Islam Finance NotesFinance notes Finance notes 8

HBC608HBC608 ECON582 HBC608 Labor Productivity Capital is the most responsible resource for increasing labor productivity. New Technology is another factor that increase labor productivity. Two broad categories of capital Human Capital Accumulated knowledge, skill, (come from education and training) and experience of the labor force. As individual workers acquire more human capital, their productivity and income increase Physical Capital Includes the machines, buildings, roads, airports, communication networks and other manufactured creations used to produce goods and services. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 9

Labor Productivity Dr. Mazharul Islam HBC608HBC608 ECON582 HBC608 Labor Productivity Expresses the relationship between the amount of capital per worker (horizontal axis) and the output per worker (vertical axis), other things constant (level of technology). y k PF Capital per worker Any point on the production function, PF, shows how much output per worker can be produced for a given amount of capital per worker. Output per worker When there are k units of capital per worker, average output per worker in the economy is y. Upward slope of the curve occurs because an increase in capital per worker helps each worker produce more output (Simon Kuznets: 1/10 of the increase in economic growth). Dr. Mazharul Islam Finance notes Finance NotesFinance notes 10

Impact of Technology on Labor Productivity ECON582 HBC608 HBC608HBC608 Impact of Technology on Labor Productivity Technological change usually improves the quality of capital and increases productivity, shown by the upward rotation from PF to PF'  more output is produced at each level of capital per worker (Simon Kuznets: 9/10 of the increase in economic growth). O u t p e r w o k y Capital per worker PF y' PF' Dr. Mazharul Islam Finance notes Finance NotesFinance notes 11

HBC608HBC608 ECON582 HBC608 Standard of living The Real GDP (Output) per capita is the best measure of economy’s standard of living. Because it indicates how much an economy produces on average per person. Real GDP per person = Real GDP/ population . Real GDP per person grows only if real GDP grows faster than the population grows. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 12

Preconditions for Economic Growth HBC608HBC608 ECON582 HBC608 Preconditions for Economic Growth An incentive system is requires for Economic Growth that created by economic freedom, property rights , and markets. These three also depends on political stability. http://www.youtube.com/watch?v=y8HPZElenO8 http://www.youtube.com/watch?v=RAoMHt28gfM Economic Freedom refers a condition in which people are able to make personal choices, and they are free to buy and sell in the markets. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 13

Preconditions for Economic Growth HBC608HBC608 ECON582 HBC608 Preconditions for Economic Growth Property rights refers the social arrangements that rule the protection of private property. Property rights include the rights to physical property, financial property, and intellectual property. Property rights provide the people with the incentive to work & save. Markets refers a place where buyers and sellers get information and do business with each other, and where market prices send signals to buyers and sellers that create incentive to increase quantities demanded and supplied. Free markets enable people to trade, save, and invest. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 14

Preconditions for Economic Growth HBC608HBC608 ECON582 HBC608 Preconditions for Economic Growth The previous three conditions (economic freedom, property rights, and markets) work together to create incentives for people to: specialize and trade save and invest expand their human capital, and discover and apply new technologies. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 15

Policies to achieve Faster Economic Growth HBC608HBC608 ECON582 HBC608 Policies to achieve Faster Economic Growth To achieve faster economic growth we must increase: The growth rate of capital per hour of labor or The pace of technological change. The main suggestions for achieving these objectives are: Encourage (Stimulate) Saving Encourage (Stimulate) Research and Development Encourage International Trade Improve the Quality of Education Create incentive mechanisms Dr. Mazharul Islam Finance NotesFinance notes Finance notes 16

Encourage (Stimulate) Saving HBC608HBC608 ECON582 HBC608 Encourage (Stimulate) Saving In general, saving finances investment, which brings capital accumulation. It means that encouraging saving can increase the growth of capital which turn to economic growth. Higher saving rates higher growth rates One way to increase saving is to make tax incentives. Less tax More saving. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 17

Encourage Research and Development HBC608HBC608 ECON582 HBC608 Encourage Research and Development Since technological change is the fruit of research and development (R&D), investment in R&D reflects the economy’s efforts to improve productivity. Government subsidies and direct funding might stimulate basic research and development. Private organizations are funding for applied research such as Apple Computer, iPhone, etc. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 18

Encourage International Trade HBC608HBC608 ECON582 HBC608 Encourage International Trade Free international trade stimulates economic growth by extracting all the available gains from specialization and trade. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 19

Improve the Quality of Education HBC608HBC608 ECON582 HBC608 Improve the Quality of Education By funding basic education and by ensuring high standards in skills such as language, mathematics, and science, governments can contribute enormously to a nation`s growth potential. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 20

Create incentive mechanisms HBC608HBC608 ECON582 HBC608 Create incentive mechanisms Economic growth occurs when the incentives to save , invest ,and innovate are strong enough. These incentives require property rights enforced by a well – functioning legal system. Dr. Mazharul Islam Finance NotesFinance notes Finance notes 21

Now it’s over for today. Do you have any question? HBC608 ECON582 HBC608HBC608 Now it’s over for today. Do you have any question? Dr. Mazharul Islam Finance NotesFinance notes Finance notes 22