Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik1 Universität Leipzig Introduction to Economics Lecture 8: Growth Alexander Fink, PhD

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik2 Production and Growth A countrys standard of living depends on its ability to produce goods and services. A nations standard of living is determined by the productivity of its workers. ProductivityProductivity refers to the amount of goods and services produced for each hour of a workers time.

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik3 Copyright©2004 South-Western The Variety of Growth Experiences

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik4 Growth Rates and Economic Development Annual growth rates that seem small become large when compounded for many years. Compounding refers to the accumulation of a growth rate over a period of time. With annual growth rates of 2% in GDP per capita the living standard doubles each 36 years. With annual growth rates of 2% in GDP per capita the living standard triples each 36 years.

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik5 5 World per capita income (PPP) Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1):

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik6 6 Per capita income (PPP) per region Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1):

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik7 7 Infant Mortality Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1):

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik8 8 Life Expectancy Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1):

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik9 9 Education Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1):

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik10 Democracy Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1):

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik11 Inflation Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1):

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik12 Top marginal income tax Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1):

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik13 Tariffs Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1):

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik14 Procedures to start business Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1):

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik15 Productivity: Its Role and Determinants Productivity plays a key role in determining living standards for all nations in the world. What affects productivity? The factors of production directly determine productivity: –Physical capital –Human capital –Natural resources –Technological knowledge

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik16 Physical Capital –is a produced factor of production. It is an input into the production process that in the past was an output from the production process. –is the stock of equipment and structures that are used to produce goods and services. Tools used to build or repair automobiles. Tools used to build furniture. Office buildings, schools, etc. How Productivity Is Determined

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik17 Human Capital –the economists term for the knowledge and skills that workers acquire through education, training, and experience Like physical capital, human capital raises a nations ability to produce goods and services. How Productivity Is Determined

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik18 Natural Resources –inputs used in production that are provided by nature, such as land, rivers, and mineral deposits. Renewable resources include trees and forests. Nonrenewable resources include petroleum and coal. –can be important but are not necessary for an economy to be highly productive in producing goods and services. How Productivity Is Determined

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik19 Technological Knowledge –societys understanding of the best ways to produce goods and services. –Human capital refers to the resources expended transmitting this understanding to the labor force. How Productivity Is Determined

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik20 The Production Function Economists often use a production function to describe the relationship between the quantity of inputs used in production and the quantity of output from production. Y = A F(L, K, H, N) Y = quantity of outputK = quantity of physical capital L = quantity of laborH = quantity of human capital A = available production technology N = quantity of natural resources

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik21 Economic Growth and Public Policy Governments can do many things to raise productivity and living standards. –Encourage saving and investment. –Encourage investment from abroad –Encourage education and training. –Establish secure property rights and maintain political stability. –Promote free trade. –Promote research and development.

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik22 One way to raise future productivity is to invest more current resources in the production of capital. When savings increase, more capital is produced The stock of capital grows and can in the future be used to produce a larger quantity of goods and services The Importance of Saving and Investment

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik23 As the stock of capital rises, the extra output produced from an additional unit of capital falls; this property is called diminishing returns. Because of diminishing returns, an increase in the saving rate leads to higher growth only for a while. In the long run, the higher saving rate leads to a higher level of productivity and income, but not to higher growth in these areas. Diminishing Returns and the Catch-Up Effect

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik24 BIP pro Kopf der Bevölkerung WesteuropaEuropäische AblegerJapan Asien (ohne Japan)LateinamerikaOsteuropa Afrika 1990 in Dollar Source: Maddison Wirtschaftswachstum rund um die Welt Abbildung 2: Abnehmender Grenzertrag des Kapitals 2008 © Schäffer-Poeschel Verlag für Wirtschaft Steuern Recht GmbH Institut für Wirtschaftswissenschaft. Universität Erlangen-Nürnberg. 1 1 Output per worker Capital per worker 2. When the capital stock is large, an additional increase in capital leads to a small increase in output per worker. 1. When the capital stock is small, an additional increase in capital leads to a large increase in output per worker.

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik25 From diminishing returns results the catch up effect The catch-up effect refers to the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich. With a small stock of capital per worker the productivity of additional investments in capital is relatively high. Diminishing Returns and the Catch-Up Effect

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik26 Governments can increase capital accumulation and long-term economic growth by encouraging investment from foreign sources. Investment from abroad takes several forms: –Foreign Direct Investment Capital investment owned and operated by a foreign entity. –Foreign Portfolio Investment Investments financed with foreign money but operated by domestic residents. Investment from Abroad

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik27 For a countrys long-run growth, education is important. –One way the government can enhance the standard of living is to provide schools and encourage the population to take advantage of them. –An educated person might generate new ideas about how best to produce goods and services, which in turn, might enter societys pool of knowledge and provide an external benefit to others. Education

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik28 Property rights refer to the ability of people to exercise authority over the resources they own. –An economy-wide respect for property rights is an important prerequisite for the price system to work. –It is necessary for investors to feel that their investments are secure. Property Rights and Political Stability

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik29 Trade is, in some ways, a type of technology. A country that eliminates trade restrictions will experience the same kind of economic growth that would occur after a major technological advance. Some countries engage in... –... inward-orientated trade policies, avoiding interaction with other countries. –... outward-orientated trade policies, encouraging interaction with other countries. Free Trade

Winter Semester 2011Alexander Fink, Institut für Wirtschaftspolitik30 Literature Source: Shleifer, Andrei "The Age of Milton Friedman." Journal of Economic Literature 47(1): : hleifer/files/JEL_2009_final.pdf hleifer/files/JEL_2009_final.pdf