Principles of Macroeconomics: Ch 12 First Canadian Edition Overview-7 u How economic growth differs around the world u Why productivity is the key determinant of a country’s standard of living u Factors that determine a country’s productivity u How a country’s policies influence growth

Principles of Macroeconomics: Ch 12 First Canadian Edition Production and Growth u A country’s standard of living depends on its ability to produce goods and services. u Within every country there are large changes in the standard of living over time.

Principles of Macroeconomics: Ch 12 First Canadian Edition Economic Growth Around the World u Living standards, as measured by per capita real GDP, vary significantly among nations. u The most developed countries have real per capita GDP that is ten to twenty times that of the poorest countries. u The process of creating a high living standard is keyed to productivity.

Principles of Macroeconomics: Ch 12 First Canadian Edition Productivity u Recall one of the Ten Principles from Chapter 1: A country’s standard of living depends on its ability to produce g & s. u This ability depends on productivity: the average quantity of g&s produced per unit of labour input. u y = real GDP = quantity of output produced L = quantity of labour so we can write productivity as y/L (output per worker)

Principles of Macroeconomics: Ch 12 First Canadian Edition The Rule of 70 u Annual growth rates that seem small become large when compounded for many years. – Compounding refers to the accumulation of a rate over a period of time. u Rule of 70: The value of a variable will double in approximately (70 ÷ annual growth rate) years. u Grow at 7% and double in 10 years.

Principles of Macroeconomics: Ch 12 First Canadian Edition The Rule of 70: Example $5,000 invested at 7 percent interest per year, will double in size in 10 years 70 ÷ 7 = 10

Principles of Macroeconomics: Ch 12 First Canadian Edition Assignments etc. u Assignment 1 ODD and EVEN are now on my web page—Due in 2nd meeting u Chapter 6 notes are up Ch 5 soon u Deferred December exam (med cert and other valid reasons-NOT a grade- raiser) Date etc to be announced in class soon. Late Jan or early Feb.

Principles of Macroeconomics: Ch 12 First Canadian Edition REAL AND NOMINAL u Real removes price effects. Nominal is “current dollar”-current prices. u Real income (GDP) y=Y/P>> Y=P*y u Real wages w= W/P u Real interest r=i-pdot u With 0 inflation P is constant, pdot=0 and nominal = real. u “economic growth” always refers to real

Principles of Macroeconomics: Ch 12 First Canadian Edition Productivity: Role and Determinants u To understand the large differences in living standards we focus on how goods and services are produced. u Productivity refers to the quantity of goods and services that a worker can produce for each hour of work. u The inputs used to produce goods and services are called the factors of production.

Principles of Macroeconomics: Ch 12 First Canadian Edition How Productivity is Determined u The Factors of Production include: – Physical Capital--K – Human Capital – Natural Resources – Technological Knowledge v Capital (K) is a produced factor of production, i.e. capital is an input into the production process that in the past was an output from production. Eg machines.

Principles of Macroeconomics: Ch 12 First Canadian Edition The Factors of Production: Physical Capital u The stock of equipment and structures that are used to produce goods and services. u Examples: – Tools used to build or repair automobiles – Tools used to build homes or buildings – Buildings, e.g. Factories, offices, schools,

Principles of Macroeconomics: Ch 12 First Canadian Edition The Factors of Production: Human Capital u The economist’s term for the knowledge and skills that workers acquire through education, training, and experience. u Like physical capital, human capital raises a nation’s ability to produce goods and services. SKILLS

Principles of Macroeconomics: Ch 12 First Canadian Edition u Inputs used in production that are provided by nature, such as land, rivers, and mineral deposits. They are not necessary for an economy to be highly productive. Hong Kong u Renewable Resources: v Trees, forests – Non-Renewable Resources: v Oil, coal, POTASH The Factors of Production: Natural Resources

Principles of Macroeconomics: Ch 12 First Canadian Edition The Factors of Production: Technological Knowledge u The understanding of the best ways to produce goods and services. u Technological Knowledge refers to society’s understanding about how the world works. u Human Capital refers to the resources expended transmitting this understanding to the labour force.

Principles of Macroeconomics: Ch 12 First Canadian Edition Economic Growth and Public Policy u Public policies, laws, traditions, and institutions are critical to transforming resources into useful output. u Governments can do many things to encourage or impede the attainment of high living standards.

Principles of Macroeconomics: Ch 12 First Canadian Edition Economic Growth and Public Policy u Government policies: – Encourage saving and investment – Encourage education and training – Establish secure property rights and political stability – Promote free trade policies – Promote research and development

Principles of Macroeconomics: Ch 12 First Canadian Edition Government policies: Encourage saving and investment u One way to raise future productivity is to invest more current resources in the production of capital. u Governments can encourage capital accumulation: – from domestic sources by imposing low taxes on interest and dividend income. – from foreign sources by making such capital secure and welcome domestically.

Principles of Macroeconomics: Ch 12 First Canadian Edition Saving and Investment u We can boost productivity by increasing K, which requires investment. u Since resources are scarce, producing more capital requires producing fewer consumption goods. u Reducing consumption = increasing saving. This extra saving funds the production of investment goods. (More details in the next chapter.) u Hence, a tradeoff between current and future consumption.

Principles of Macroeconomics: Ch 12 First Canadian Edition Government policies: Encourage saving and investment u Cautions: – As the stock of capital rises, the extra output produced from an additional unit of capital falls (diminishing returns). – As the higher saving rate allows more capital to be accumulated, the benefits from additional capital become smaller over time, and so growth slows down.

Principles of Macroeconomics: Ch 12 First Canadian Edition Government policies: Encourage education and training u Education is at least as important as investment in physical capital. u Most countries provide basic education so that the work force can acquire the specialized skills leading to higher productivity.

Principles of Macroeconomics: Ch 12 First Canadian Edition Government policies: Establish secure property rights and political stability u Property rights refer to the ability of people to exercise authority (ownership) over the resources they own. u An economy-wide respect for property rights is an important prerequisite for the price system to work. u It is necessary for investors to feel that their investments are secure and safe from political instability and expropriation.

Principles of Macroeconomics: Ch 12 First Canadian Edition Government policies: Promote Free Trade u To exploit comparative advantage and maximize production and efficiency, it is important for countries to have the opportunity to sell abroad and to be able to purchase from lower opportunity cost producers. u Some countries engage in: – Inward-oriented trade policies-Tariffs – Outward-oriented trade policies

Principles of Macroeconomics: Ch 12 First Canadian Edition Government policies: Research and Development u The advancement of technological knowledge has led to higher standards of living. Technological advancement comes from private firms and public agencies. Positive externalities. u Government’s role is to encourage the research and development of new technologies through research grants, tax credits, and the patent system.

Principles of Macroeconomics: Ch 12 First Canadian Edition Conclusion u Living standards, as measured by real GDP per capita, vary substantially from country to country. u In the long run, living standards are determined by productivity. u Policies that affect the determinants of productivity will therefore affect the next generation’s living standards. u Government policies and actions can facilitate or impede economic growth.