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) EG 7% = 10 years 2% = 35 years 1% = 70 years

 

 Determining potential GDP

 

Aggregate production function

How much output we can get for some combination of inputs

 



 

	Output
	Labour
	Capital
	Total Productivity
	Function

*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

 

 

 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
Effects	Growth in working age population causes growth in hours supplied Productivity needs to increase to maintain RGDP per person (when RDP increases)
Causality	Working age population rises Labour supply curve shifts right real wage rate fall aggregate hours increase increases potential GDP decreases real GDP per hour of labour (due to diminishing returns)

 

 

2. Growth in labour productivity

 

Labour productivity
Effects	When labour productivity rises: Firms are willing to pay more for a given number of hours Demand of labour increases
Causality	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	Firms Markets Well-defined property rights Money
Determinants	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

 



 

 

 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) Method: 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.

 

 

 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 Problems: 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.

 

 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.