Trends in U.S Economic Growth Growth in the U.S. Economy  From 1908 to 2008, annual growth in real GDP per person in the United States averaged 2%.  Real GDP per person fell precipitously during the Great Depression and rose rapidly during World War II.  Growth was most rapid during the 1960s.  Growth slowed during the 1970s and sped up again in the 1980s and1990s.

Economic Growth Trends

Economic Growth in U.S. vs. Poor Countries  The gaps between real GDP per person in the United States and in these countries have widened.  Some economies are converging  Some are diverging

Sources of Economic Growth  Economic growth is the sustained, year-on-year increase in potential GDP. Potential GDP is the quantity of real GDP produced when the quantity of labor employed is the full- employment quantity. Short run fluctuations in real GDP resulting from the business cycle are not the basis for economic growth

Determinants of Potential GDP  Aggregate production function Real GDP changes as the quantity of labor changes, other things held constant. An increase in labor increases real GDP. Diminishing marginal returns cause RGDP to rise at slower rate as L rises

Determinants of Potential GDP  Aggregate Labor Market real wage rate – money wage rate divided by the price level. demand for labor – shows the quantity of labor demanded as a function of the real wage rate. – determined by the marginal product of labor supply of labor –shows the quantity of labor supplied as a function of the real wage rate.

The Labor Market and Potential GDP Labor Demand Curve The demand for labor is the relationship between the quantity of labor demanded and the real wage rate when all other influences on hiring plans remain the same. Marginal product of labor curve is same as labor demand curve  Firms will always hire workers if MP> real wage  Profit maximizing firm hires until MP= real wage

The Labor Market and Potential GDP Labor supply curve  shows quantity of labor supplied for each real wage rate. Quantity of labor supplied increases as the real wage rate increases for two reasons: 1. Hours per person increase (assuming IE<SE)  Income effect (work less if real wage increases)  Substitution effect (work more if real wage increases) 2. Labor force participation increases

Determinants of Potential GDP

How Potential GDP Grows  Increase in the supply of labor taxes on workers population growth demographics retirement incentives household technology  Increase in demand for labor more productive labor Human capital physical capital technological improvements reduced payroll taxes on employers

Effect of increase in labor supply real wage labor hours real GDP productivity (RDGP per hour) real GDP per capita depends on whether population increased

Effect of increase in labor demand due to increased productivity Labor demand increases and PF shifts upward. real wage labor hours real GDP productivity real GDP per capita

 The incentive system created by firms, markets, property rights, and money.  The growth of labor productivity depends on Physical capital growth Human capital growth Technological advances Why Labor Productivity Grows

Growth Theories and Policies  Classical growth theory growth of real GDP per person is temporary when GDP per person rises above the subsistence level, a population explosion eventually brings real GDP per person back to the subsistence level. Malthus – the “dismal science”

Growth Theories and Policies Modern Growth Theory  Real GDP per person grows because technological change induces a level of saving and investment that makes capital per hour of labor grow.  Growth ends only if technological change and/or incentives for technological change stops.

Growth Theories and Policies  New growth theories Real GDP per person grows because of choices that people make in the pursuit of profit and growth can persist indefinitely. Technological change is driven by profit incentives Knowledge is a public good and there may be increasing returns to knowledge (education)

Achieving Faster Growth  Must increase the growth rate of capital per hour of labor or increase the pace of technological change.  Policies for growth stimulate saving with tax incentives stimulate investment with tax incentives and appropriate regulatory environment (e.g. patents) Stimulate research & development. Growth Theories and Policies

 Stimulate Research and Development Because the fruits of basic research and development efforts can be used by everyone, not all the benefit of a discovery falls to the initial discoverer. The market might allocate too few resources to research and development. Government subsidies and direct funding might stimulate basic research and development. Patents can provide incentive to innovate. Growth Theories and Policies