Ch 22 - Economic Growth

Friday, April 06, 2012

3:58 PM

    Economic growth

    Growth over time in Potential GDP

    • Grow in a compounded fashion

    Economic growth rate

    Note: In terms of living standards, real GDP per person is a better measurement


    Rule of 70

    The length of time it takes a number to double (compounding)
    7% = 10 years
    2% = 35 years
    1% = 70 years


    Important Determining potential GDP


    Aggregate production function

    How much output we can get for some combination of inputs






    Total Productivity


    *For text, K and A is fixed to see how Y changes when L changes


    Aggregate Labour Market

    Where firms demand labour, and workers supply it

    Real wage rate (Y-Axis)

    Labour (X-Axis)

    Amount of labour (hours/year)

    *Full employment occurs when Real wage rate = Labour



    Important Factors that Makes Potential GDP grow:


    1. Growth in the supply labour


    Depends on

    Hours per worker
    Fraction of people employed
    Total working age population


      • Growth in working age population causes growth in hours supplied
      • Productivity needs to increase to maintain RGDP per person (when RDP increases)


    Working age population rises
    Labour supply curve shifts right

    Machine generated alternative text: j60
1 s
0 10 20 30 40 50
Labour (bIorn of houri per year)

    real wage rate fall
    aggregate hours increase
    increases potential GDP

    Machine generated alternative text: O lO 20 30 40 50
Lcow (bilions of hours per year)

    decreases real GDP per hour of labour (due to diminishing returns)



    1. Growth in labour productivity


    Labour productivity


    When labour productivity rises:

    • Firms are willing to pay more for a given number of hours
    • Demand of labour increases


    Increase in labour productivity
    Production function shifts upward (more is produced per hour by individuals)
    Increase in the demand for labour
    Real wage rate rises (with no change in supply)
    Aggregate hours increase
    Total production increases further



    Need to create incentives for specialization and trade


    Key components

    Well-defined property rights


    Physical capital growth
    Human capital growth
    Technological advances

    Physical Capital Growth

    Accumulation of new capital
    Increase capital per worker
    Increase labour productivity

    Human Capital Growth

    Human capital acquired through education, training
    Enables individuals to work smarter
    Produces more per hour
    Increase labour productivity growth.

    Technological advances


    Machine generated alternative text: Change in average hours per worker
Change in employment to-population
Working-age population growth
Physical capitol growth
Human capital growth
. Education and training
• Job experience
Technological advances
Real GDP
Real GDP per



    Question Productivity growth is due to

    • Capital growth? Or
    • Technological change?


    Growth accounting

    Method that separate contribution of various factors to productivity growth
    (using a residual measure for tech change)

    Research found that 1% increase in capital increases productivity by 0.49%
    if productivity rises by 0.49% and capital/worker rises by 3%, 1.03% must be technological change.



    Important Theories


    Classical Growth Theory

    Begin with minimal (subsistence) real wage rate (GDP per hour of labour)
    Advances in technology -> investment in new capital.
    Labour productivity increases (higher GDP/capita)
    Real wage rate rises above minimal (subsistence) level
    Population growth increases the supply of labour (causing diminishing returns to labour)
    Causes real wage to fall
    Population continues to growth until real wage fall back to subsistence level
    At subsistence level, population growth and economic growth stop.

    Not supported.

    • Population growth does not link to income per person
    • Population growth does not drive incomes down

    Neoclassical growth theory

    Technological change occurs.
    New profit opportunities arise.
    Increase in saving and investment
    Increase in capital stock.
    Real GDP per person rises.
    Growth in Real GDP per person only continues if tech continues to advance.
    High rates of capital accumulation causes rates of lowers return to investment in capital (due to investments in poorer projects)
    Creates disincentive to invest in capital.
    Lowers Growth


    • Technology is accessible to all economies, seeks highest available real interest rate.
    • Economic growth rates and real GDP per person does not converge like indicated.

    New Growth Theory

    Pursuit of profit drives innovation and technological change.

    • Increasing competition reduces profits, gives incentive to constantly innovate

    Economic growth, increases indefinitely.
    Knowledge gained from innovation has spillover effects.

    • The ability for others to used knowledge gained by one person.

    Increase capital stock lowers the return to investing in capital.
    Increases the incentive to innovate.

    Increases technological progress.

    In this case, human capital in more important; innovation drives progress.


    Important Policies

    Achieving faster growth

    Saving - Saving finances investment. This means that it can increase physical capital growth. (can be stimulated by tax incentives.)
    Research/Development - Spillover effects discourage private innovation. Government should fund this.
    Education - Spillover effects discourage. Government aid.
    International trade - increases incentive to specialize, to innovate.


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