Economic Growth

The Nature of Growth Economic growth refers to increases in the output (real GDP) – an expansion of production possibilities.

Two Types of Growth The short run — increased capacity utilization The long run — expanded capacity

Short-Run Changes in Capacity Use The easiest kind of growth comes from the increased use of our productive capacity.

Short-Run Changes in Capacity Use We do not always take full advantage of our productive capacity.

Short-Run Changes in Capacity Use Productive capacity is illustrated by the production possibilities curve. Production possibilities are the alternative combinations of final goods and services that could be produced in a given time period with all available resources and technology.

Short-Run Growth: Increased Capacity Utilization CONSUMPTION GOODS (quantity per year) INVESTMENT GOODS (quantity per year) B A

Long-Run Changes in Capacity To achieve large and lasting increases in output, the production possibilities must be pushed outward.

Long-Run Changes in Capacity Economists tend to define economic growth in terms of changes in potential GDP.

Long-Run Growth: Expanded Capacity CONSUMPTION GOODS (quantity per year) INVESTMENT GOODS (quantity per year) A C B

Aggregate Supply Focus Economic growth is possible only if the AS curve shifts right.

Supply-Side Focus DETERMINANTS OUTCOMES Jobs Internal market AS forces Output Jobs Prices International balances Internal market forces External shocks AD AS Growth Policy levers: fiscal policy monetary policy supply-side policy

Nominal vs. Real GDP Economic growth refers to increases in real GDP.

Nominal vs. Real GDP Nominal GDP is the total value of goods and services produced within a nation’s borders, measured in current prices.

Nominal vs. Real GDP Real GDP is the inflation-adjusted value of GDP; the value of output measured in constant prices.

The GDP Growth Rate Growth rate is the percentage change in real GDP from one period to another. Growth Rate = change in real GDP base period GDP

The GDP Growth Rate Challenge for the future is to maintain higher rates of economic growth.

Recent U.S. Growth Rates GROWTH RATE (percent per year 1.0 -2.0 -3.0 -1.0 2.0 3.0 4.0 5.0 6.0 7.0 GROWTH RATE (percent per year 1960 1964 1968 1972 1976 1980 1984 1988 1992 2000 1996 2004

The Exponential Process Even one year of “low” growth implies lost output. Economic growth is a continuing process. Gains made in one year accumulate in future years.

GDP per Capita: A Measure of Living Standards GDP per capita — total GDP divided by total population. It is average GDP.

GDP per Capita: A Measure of Living Standards Growth in GDP per capita is attained only when growth of output exceeds population growth.

GDP per Capita: A Measure of Living Standards U.S. GDP per capita has more than doubled since Ronald Reagan was president.

The History of World Growth 1000 1500 1820 1995 $6,000 5,000 4,000 3,000 2,000 1,000

The Rule of 72 Small differences in annual growth rates cumulate into large differences in GDP. Seventy-two divided by the growth rate equals the number of years it takes to double.

The Rule of 72

GDP per Worker GDP per worker is a measure of productivity Average workers today produce nearly twice as much as their parents.

GDP per Worker The U.S. labor force grew faster than the population during the 1990s. The labor force includes all persons over age sixteen who are either working for pay or actively seeking paid employment.

GDP per Worker The U.S. employment rate also increased. The employment rate is the proportion of the population that is employed.

GDP per Worker If productivity is increasing, then per capita GDP is likely to rise as well. Productivity is measured as output per unit of input, such as a labor hour.

Average annual productivity increase 1990-99 Productivity Gains Average annual productivity increase 1990-99 5.3 4.1 4.2 2.6 2.7 2.5 2.0 1.8 Italy Great Britain Japan United States Canada France Germany Sweden

Sources of Productivity Growth Sources of productivity gains include: Higher skills More capital Improved management Technological advance

Labor Quality As education and training levels rise, so does productivity.

Capital Investment Capital investment is a prime determinant of productivity and growth. Investment refers to expenditures on new plant and equipment in a given time period, plus changes in business inventories.

Average Annual Growth Rate of Labor, Capital, and Productivity

Management Entrepreneurship and the quality of continuing management are major determinants of economic growth.

Management There is a potential conflict between short-term profits and long-term productivity gains.

Management Managers must develop personnel structures and incentives that make employees want to contribute to production.

Research and Development Scientific research Product development Innovations in production technique Development of management improvements

Policy Levers Government policies can have a major impact on whether, and how far, the aggregate supply curve shifts.

Education and Training Government spending on education and training has two payoffs: It stimulates the economy in the short run. It increases the long-run capacity to produce.

Immigration Policy The quality and quantity of labor are affected by immigration policy. Direct contributor to outward shift of production possibilities. Recent immigrants have lower educational level than native-born Americans.

Investment Incentives Tax policy is not only a staple of short-term stabilization policy but a determinant of long-run growth as well.

Savings Incentives Supply-side economists favor tax incentives encouraging saving as well as greater tax incentives for investment. Saving is that part of disposable income not spent on current consumption.

Government Finance When government borrows to finance its spending, it dips into the nation’s saving pool.

Government Finance Crowding out is a reduction in private-sector borrowing (and spending) caused by increased government borrowing.

Government Finance Crowding in is a increase in private-sector borrowing (and spending) caused by decreased government borrowing.

Government Finance Fiscal and monetary policies must be evaluated in terms of impact on long-run aggregate supply as well as short-run aggregate demand.

Deregulation Government regulations impacts aggregate supply by: Limiting the flexibility of producers to respond to changes in demand. Raising production costs.

Deregulation Factor Markets Minimum wage laws. OSHA standards. More people would be hired without regulation.

Deregulation Product Markets Transportation costs Food and drug standards Regulation causes restricted supply

Deregulation The basic contention of supply-side economists is that regulatory costs are too high.

Economic Freedom Nations with the most economic freedom have the highest GDP per capita and grow the fastest.

2001 Levels of Economic Freedom 2000 Per Capita Income in Purchasing Power Parties $26,855 5,000 10,000 15,000 20,000 Repressed Mostly unfree Free Mostly free 25,000 $12,569 $3,229 $3,585 Hong Kong New Zealand Luxembourg United States Canada Japan Peru Mexico Indonesia Brazil Egypt Russia Libya Belarus Cuba North Korea

Is More Growth Desirable? More growth can lead to: Congestion Air pollution Depleted natural resources

Is More Growth Desirable? The debate usually centers around the mix of goods and services being provided rather than the quantity of output.

Economic Growth End of Chapter 14