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Principles and Policies I: Macroeconomics Chapter 8: Growth, Productivity, and the Wealth of Nations Chapter Eight Learning Objectives You should be able to: Define growth and relate it to living standards. List five sources of growth.

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principles and policies i macroeconomics

Principles and Policies I: Macroeconomics

Chapter 8: Growth, Productivity, and the Wealth of Nations

Maclachlan, Macroeconomics 10/6/04

chapter eight learning objectives you should be able to
Chapter Eight Learning ObjectivesYou should be able to:
  • Define growth and relate it to living standards.
  • List five sources of growth.
  • Distinguish diminishing marginal productivity from decreasing returns to scale.
  • Distinguish Classical growth theory from new growth theory.
  • List and discuss six government policies to promote growth.

Maclachlan, Macroeconomics 10/6/04


Queen Elizabeth owned silk stockings. The capitalist achievement does not typically consist in providing more silk stocking for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.

--Joseph Schumpeter

Maclachlan, Macroeconomics 10/6/04

growth is an increase in potential output
Growth is an increase in potential output

Potential Output: the highest amount of output an economy can produce from the existing production function and the existing resources.

Maclachlan, Macroeconomics 10/6/04

compounding effect
Compounding Effect

Rule of 72: the number of years it takes for a certain amount to double in value is equal to 72 divided by its annual rate of increase.

Maclachlan, Macroeconomics 10/6/04


Today, the U.S. poverty level for a family of four is about $18,000. If we go back 100 years in U.S. history, and adjust for inflation, that $18,000 would put a family in the upper middle class.

Maclachlan, Macroeconomics 10/6/04

cost of goods in hours of work

Milk (½ gallon)

Beef (1 pound)


Eggs (1 dozen)

Bread (1 pound)

Chicken (3 lb. fryer)

Milk (½ gallon)

Beef (1 pound)


Eggs (1 dozen)

Bread (1 pound)

Chicken (3 lb. fryer)






Price in minutes of work

Cost of Goods in Hours of Work

Maclachlan, Macroeconomics 10/6/04

sources of growth
Sources of Growth
  • Capital accumulation.
  • Available resources.
  • Growth-compatible institutions.
  • Technological development.
  • Entrepreneurship.

Maclachlan, Macroeconomics 10/6/04

production function
Production Function

Maclachlan, Macroeconomics 10/6/04

returns to scale
Returns to Scale

How output responds to an increase in all factors of production

Constant return to scale: output increases in the same proportion as factors

Decreasing returns to scale: output increases in a lesser proportion than factors

Maclachlan, Macroeconomics 10/6/04

marginal productivity
Marginal Productivity

Effect on output of increasing one factor of production.

Example: diminishing marginal productivity of labor

Maclachlan, Macroeconomics 10/6/04

classical growth model
Classical Growth Model

A model of growth that focuses on the role of capital accumulation in the growth process.

Maclachlan, Macroeconomics 10/6/04

diminishing returns and population growth

Subsistence level of output per worker


Production function






Diminishing Returns and Population Growth

Maclachlan, Macroeconomics 10/6/04

new growth theory
New Growth Theory

Theory that emphasizes the role of technology rather than capital in the growth process.

Increasing returns can result from positive externalities and learning by doing.

Maclachlan, Macroeconomics 10/6/04


In 1980, Julian Simon, the recently deceased economist and author of "The Ultimate Resource," offered to environmentalists a wager based on his assertion that the price of any raw material would indefinitely decline on a future date. The wager was taken up by Paul Ehrlich, author of the best-selling 1968 book, "The Population Bomb," which predicted that during the 1970s "the world will undergo famines -- hundreds of millions of people are going to starve to death in spite of any crash programs embarked upon now." These predicted deaths were off by hundreds of millions.

Maclachlan, Macroeconomics 10/6/04


"In October 1980, Ehrlich and Simon drew up a futures contract obligating Simon to sell Ehrlich the same quantities which could be purchased for $1,000 of five metals (copper, chrome, nickel, tin, and tungsten) ten years later as 1980 prices," writes Ronald Bailey in his book "EcoScam." "If the combined prices rose above $1,000, Simon would pay the difference. If they fell below $1,000, Ehrlich would pay Simon. Ehrlich mailed Simon a check for $576.07 in October 1990." During the 1980s the combined prices of the metals selected by Ehrlich declined by over 50 percent. Simon easily won because he knew that the supply for resources was not becoming more scarce but more abundant, since the economic history of predominantly free capitalist nations had demonstrated how the prices of most major commodities have declined over time.

Maclachlan, Macroeconomics 10/6/04

economic policies to promote growth
Economic Policies to Promote Growth
  • Encourage saving and investment.
  • Control population growth.
  • Increase level of education.
  • Create institutions that encourage technological innovation.
  • Provide funding for basic research.
  • Increase economy’s openness to trade.

Maclachlan, Macroeconomics 10/6/04