1. Late 1990s and Productivity
Review
The long run aggregate supply curve (LRAS) curve is a placeholder for potential GDP (GDPP).
The aggregate supply curve (AS) curve upward sloping
Potential GDP (GDPP) is what GDP equals whenever the actual inflation rate () turns out to equal the expected inflation rate (E).
 (%)
LRAS AS
 The aggregate supply (AS) curve intersects the long run aggregate supply (LRAS) curve at the expected inflation rate (E). E
Adaptive expectations: The expected inflation rate (E) depends on the actual inflation rate in the recent past.
GDPP
G&S
Late 1990s
Unemp
Real
Actual Infl
Govt
Year
Rate (%)
GDP
Purch
1995
5.6
10,165
2.1
2,260
1996
5.4
10,550
1.8
2,280
1997
4.9
11,025
1.7
2,320
1998
4.5
11,515
1.1
2,370
Average growth rate in the eight decades
= 3.3%
3.8%
4.5%
4.4%

2. Adaptive Expectations
Clinton Years
Adaptive Expectations
LRAS curve is vertical and a placeholder for potential GDP (GDPP).
Unemp Real Actual Infl Expected Infl Govt
Year Rate (%) GDP Rate (%) Rate (%) Pur
Potential GDP: GDP whenever actual inflation () equals expected inflation (E).
, ,260
2.1
1996
5.4 10,
2.1
2,280
What had to happen to the AS curve in 1996?
What had to happen to the LRAS curve in 1996?
What had to happen to potential GDP in 1996?
The AS curve intersects the LRAS curve at the expected inflation rate (E).
Shift right.
Shift right.
Increase.
 (%)
AS1995
AS1995,1996
First consider 1995
LRAS1995
LRAS1996
AS1996
In 1995, E =
2.1
In 1995,  =
2.1
2.25
In 1995, GDPP =
10,165
E in = 2.1%
Now, consider 1996
2.00
1995
1996
In 1996, E =
2.1
Based on E should the AS curve shift?
1.75 No
AD1995
AD1996
1.50
What happened to the AD curve in 1996?
Shift right.
10,000
10,250
10,500
10,750
G&S

3. Question: How could potential GDP increase?
Answer: Increase in population.
Increase in worker productivity.
In 1870, percent of all Americans were employed in agriculture.
Real GDP
Year Population (billions of 2009 $)
,600,000 2,020
,000,000 8,475
Today the figure is 2-3 percent.
American farmers are far more productive to than in the nineteenth century.
Growth rate = 70%
Growth rate = 325%
Question: Productivity growth fell from an average of 2.75% in the 1950’s to 1.38% in the 1980’s. What difference does it make?
2.75% annual 1.38% annual
growth rate growth rate
First year $50,000 $50,000
Question: Why the decline?
$194,000
$99,000
Fifty years later

4. Determinants of Productivity Growth
Diminishing Marginal Productivity: As capital per worker increases, each additional unit of new capital leads to smaller increases in productivity.
Natural Resources
Physical Capital
Claim: The productivity curve is upward sloping at a diminishing rate
Therefore, larger increments of new capital are required to achieve the same amount of productivity growth when capital per worker is initially high than when it is initially low.
Productivity Curve
Output per Worker
Question: What do we call new capital?
Answer: Investment
Capital per Worker
Human Capital
Question: Is there no “smoking gun” to explain the decline in productivity growth?
Labor Reallocation
Technology

5. U. S Productivity Growth: The Outlook for the 1990’s
Question: Based on the trend, what is the outlook for the 1990’s?
Question: What does this suggest about the standard of living in the U.S.?
Let us see what actually happened.