Introduction to Economic Growth and Instability 7 C H A P T E R

Learning Objective 10.1 FIGURE 10-1 Average Annual Growth Rates for the World Economy Economic Growth Over Time and Around the World Economic Growth from 1,000,000 B.C. to the Present

Learning Objective 10.1 FIGURE 10-2 GDP per Capita, 2006 Economic Growth Over Time and Around the World “The Rich Get Richer and... ”

Long-Run Economic Growth Learning Objective 9.1 Long-run economic growth The process by which rising productivity increases the average standard of living. FIGURE 9.1 The Growth in Real GDP per Capita, 1900–2006

Long-Run Economic Growth Learning Objective 9.1 FIGURE 9.2 Actual and Potential Real GDP Potential GDP The level of GDP attained when all firms are producing at capacity. Business cycle Alternating periods of economic expansion and economic recession.

Learning Objective 9.1 The Connection between Economic Prosperity and Health Making the Connection

In the long run, small differences in economic growth rates result in big differences in living standards. Learning Objective 10.1 Why Do Growth Rates Matter? Growth rates matter because an economy that grows too slowly fails to raise living standards. Don’t Let This Happen to YOU! Don’t Confuse the Average Annual Percentage Change with the Total Percentage Change Economic Growth Over Time and Around the World Small Differences in Growth Rates Are Important

Learning Objective 10.1 The Benefits of an Earlier Start: Standards of Living in China and Japan Making the Connection Sustained high rates of economic growth have helped Japan attain high living standards. CHINAJAPAN Life expectancy at birth71.9 years82.2 years Infant mortality (per 1,000 live births)233 Percentage of the population surviving on less than $2 per day47%0% Percentage of the population with access to treated water77%100% Percentage of the population with access to improved sanitation44%100% Internet users per 1,000 people73587

Long-Run Economic Growth Learning Objective 9.1 Calculating Growth Rates and the Rule of 70

What Determines How Fast Economies Grow? Labor productivity The quantity of goods and services that can be produced by one worker or by one hour of work. Technological change A change in the quantity of output a firm can produce using a given quantity of inputs. Learning Objective 10.2

What Determines How Fast Economies Grow? Better machinery and equipment. Increases in human capital. Learning Objective 10.2 There are three main sources of technological change: Human capital The accumulated knowledge and skills that workers acquire from education and training or from their life experiences. Better means of organizing and managing production.

Learning Objective 10.2 FIGURE 10-3 The Per-Worker Production Function What Determines How Fast Economies Grow? The Per-Worker Production Function Which Is More Important for Economic Growth: More Capital or Technological Change?

Learning Objective 10.2 FIGURE 10-4 Technological Change Increases Output per Hour Worked What Determines How Fast Economies Grow? Technological Change: The Key to Sustaining Economic Growth

Learning Objective 10.2 New growth theory: “incentives and market system” What Determines How Fast Economies Grow? If technological change is the key to growth then what encourages the technological change

Learning Objective 10.2 Why Did the Soviet Union’s Economy Fail? Making the Connection The fall of the Berlin Wall in 1989 symbolized the failure of Communism.

Learning Objective 10.2 Protecting intellectual property with patents and copyrights. Patent The exclusive right to a product for a period of 20 years from the date the product is invented. Subsidizing research and development. Subsidizing education. What Determines How Fast Economies Grow? New Growth Theory Government policy can help increase the accumulation of knowledge capital in three ways:

Learning Objective 10.4 FIGURE 10-8 There Has Been Catch-up among Industrial Countries Catch-up Among the Industrial Countries Why Isn’t the Whole World Rich? Catch-up: Sometimes, but Not Always

Learning Objective 10.4 FIGURE 10-9 Most of the World Hasn’t Been Catching Up Are the Developing Countries Catching Up to the Industrial Countries? Why Isn’t the Whole World Rich? Catch-up: Sometimes, but Not Always

Why Isn’t the Whole World Rich? Learning Objective 10.4 Why Don’t More Low-Income Countries Experience Rapid Growth? Property rights The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. Failure to Enforce the Rule of Law Rule of law The ability of a government to enforce the laws of the country, particularly with respect to protecting private property and enforcing contracts.

Learning Objective 10.4 Failure to Enforce the Rule of Law FIGURE The Rule of Law and Growth Why Isn’t the Whole World Rich? Why Don’t More Low-Income Countries Experience Rapid Growth?

Learning Objective 10.4 Wars and Revolutions Why Isn’t the Whole World Rich? Why Don’t More Low-Income Countries Experience Rapid Growth? Wars have made it impossible for countries such as Afghanistan, Angola, Ethiopia, the Central African Republic and the Congo to accumulate capital or adopt new technologies.

Learning Objective 10.4 Poor Public Education and Health Low Rates of Saving and Investment Why Isn’t the Whole World Rich? Why Don’t More Low-Income Countries Experience Rapid Growth? Many low-income countries have weak public school systems, so many workers are unable to read and write. People who are sick work less and are less productive when they do work. The low savings rates in developing countries contribute to a vicious cycle of poverty.

Why Isn’t the Whole World Rich? Learning Objective 10.4 The Benefits of Globalization FIGURE Globalization and Growth

Growth Policies Learning Objective 10.5 Enhancing Property Rights and the Rule of Law Improving Health and Education Policies with Respect to Technology Policies with Respect to Saving and Investment Is Economic Growth Good or Bad? We have seen that even small differences in growth rates compounded over the years can lead to major differences in standards of living. Therefore, there is potentially a very high payoff to government policies that increase growth rates.

How to increase the economy’s productive capacity over time. Two definitions of economic growth: The increase in real GDP, which occurs over a period of time. The increase in real GDP per capita, which occurs over time. ECONOMIC GROWTH

Per-capita GDP = GDP/population (the share of each inhabitant of the GDP on average) This definition is superior if comparison of living standards is desired. e.g., China’s 2001 GDP was $1131 billion compared to Kuwait’s $36 billion, But per capita GDP’s were $890 and $18000 respectively.

Growth in real GDP does not guarantee growth in real GDP per capita. If the growth in population exceeds the growth in real GDP, real GDP per capita will fall (lower standards of living). Expansion of total output relative to population results in: Rising real wages and income Higher standards of living

Growth as a Goal Growth is an important economic goal because it means more material abundance and ability to meet the economizing problem. Arithmetic of Growth: Rule of 70 The “rule of 70” uses the absolute value of a rate of change, divides it into 70, to tell us about the number of years it will take for some measure to double (in compound rates).

e.g., If growth rate = 3%. It will take 23 years to double GDP Small changes in the rate of growth are important. If the rate of growth increased to 4%. It will take about 18 years only to double GDP. In USA with a $12.5 trillion GDP, the difference between the rate of 3% and 4% equals 125 billion.

Main sources of growth Sources: Increasing inputs of resources Increasing productivity of resources productivity = real output per unit of input e.g., productivity of labor productivity of labor = real output / No. labor units How can we improve productivity of labor?? Two thirds of growth in USA result from improved productivity. Only one-third of U.S. growth comes from more inputs

The rate of growth of real GDP in Kuwait War and liberation effect

Main Sources of Growth Society can increase its real output growth by: Increasing its inputs of resources (Quantity). Increasing productivity of resources (Quality). (Productivity: real output per unit of input) Productivity rises with: 1) improvement in: health, training, education, and motivation of workers. 2) use of more and better machines and resources. 3) better organization and management of production. 4) reallocation of labor from less to more efficient firms.

The Business Cycle Fluctuations in economic activity Individual cycles vary substantially in duration and intensity: - short cycle - medium cycle - long term cycle

THE BUSINESS CYCLE Phases of the Business Cycle PEAK Level of business activity Time RECESSION TROUGH RECOVERY GROWTH TREND

Phases of the Business Cycle Four phases of the business cycle are identified over a several ‑ year period. A peak is when business activity reaches a temporary maximum with near/full employment and near full capacity output. At peak: Full employment Real output is close to capacity Prices likely to be high

A recession There is a decline in total output, income, and employment, lasting six months or more. It is marked by a widespread concentration of business activity in many sectors of the economy Prices fall only if a depression occurs (many prices are sticky)

A trough (recession or depression) is the bottom of the recession period. Output and employment bottom out at their lowest levels A recovery is when output and employment are expanding toward the full ‑ employment level. Price level may increase before full employment.

There are several theories about causation Momentous innovations: Major innovations may trigger new investment and/or consumption spending. railroads, automobiles, and micro-chips, have great impact on investment spending and thus on output, employment and prices. Contribute to variability of economic activity

Changes in productivity may be a related cause: When productivity expands, the economy booms. When productivity falls the economy recedes. Monetary causes: Too much money leads to inflationary boom Too little money triggers recession

Changes in total spending: Most economists agree that the level of aggregate spending is important, especially changes on capital goods and consumer durables. When total spending sinks, output, income and employment fall. When total spending rises, output, income and employment rise.

Cyclical Impact: Durables and Nondurables Durable goods output is more volatile than non-durables and services because spending on the latter usually cannot be postponed. Capital goods and consumer durables are affected the most. In recessions, firms delay the purchase of new machines and equipments and consumers repair their old appliances. In booms, firms replace their capital and consumers buy new appliances. Nondurable consumer goods are little affected by recessions.