Economic Growth

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# Economic Growth - PowerPoint PPT Presentation

Economic Growth Long-Run Economic Growth and Rising Living Standards Economic Growth Long-run economic growth Increase in real GDP per capita over time Increase in the standard of living Growth rates and the rule of 70 Business cycle Fluctuations about the long-run growth trend

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## PowerPoint Slideshow about 'Economic Growth' - MikeCarlo

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Presentation Transcript
Economic Growth

Long-Run Economic Growth

and

Rising Living Standards

Economic Growth
• Long-run economic growth
• Increase in real GDP per capita over time
• Increase in the standard of living
• Growth rates and the rule of 70
• Fluctuations about the long-run growth trend
• Recessions alternate with expansions.
Long-Run Economic Growth
• What determines the potential output?
• Labor productivity or Productivity

Amount of output one average worker can produce in an hour

• Average hours of labor

Number of hours one average worker spends at the job

• Labor force participation rate (LFPR)

Fraction of population that wants to work

• Size of population
What Determines the Potential Output?
• Breaking down the total output
What Determines the Potential Output?
• Review of some linear algebra

If Z = X ∙ Y, then % Δ Z ≈ % ΔX + % ΔY

If Z = X / Y, then % Δ Z ≈ % ΔX - % ΔY

• Applying this rule to the equation of total output
Long-Run Economic Growth
• What matters for a rising standard of living is real GDP per capita (i.e. per person)

Since

- Total real output = Productivity x Average Hours x LFPR x Population

Then

- Real output per capita = Total output ÷ Population

Real output per capita = Productivity x Average Hours x LFPR

In terms of percentage growth rates

Long-Run Economic Growth
• A tendency in most developed countries is that average hours of labor are slowly decreasing

So our last simplification is to ignore changes in average hours in the equation

% Δ Output per person ≈ % Δ productivity + % Δ LFPR

Growth in LFPR

Recall that

Growth in LFPR
• Currently, U.S. Bureau of Labor Statistics predicts the employment growth rate to be 1% per year until 2010, about the same as the growth rate of population
• If so, the % Δ LFPR ≈ % Δ Labor force - % Δ Population = 0
• Is there anything we can do to make the labor force grow faster than population, and thus increase the rate of economic growth?
• Yes
• Increase labor supply
• Increase labor demand

S

L

Real

2

Hourly

S

Wage

L

1

B

W

2

W

D

1

L

2

A

D

L

1

L

2

Millions

L

1

of Workers

The U.S. Labor Market Over A Century
How To Increase Employment
• Supply side
• Cut income tax
• Paying 40% of one’s income as taxes (federal, state, and local) discourages work effort in the United States.
• Tax cut would provide incentives to people to seek jobs
• Labor supply curve shifts rightward
• Changes in government transfer programs
• Reduce social benefits
How To Increase Employment
• Demand side
• Government policies that help increase skills of the workforce or that subsidize employment
• aid to college students
• employment subsidies to firms
Growth in Productivity
• Recently, virtually all growth in the average standard of living can be attributed to growth in productivity
• The sources for the growth in productivity
• Capital stock
• Human capital
• Technological development
• Entrepreneurship
Growth in the Capital per Worker
• One key to productivity growth is growth in nation’s capital stock
• With more capital, a given number of workers can produce more output than before
• Growth in capital stock will increase productivity as long as it increases amount of capital per worker
Investment and the Capital Stock
• A stock variable measures a quantity at a moment in time.
• Capital stock is a measure of total plant and equipment in economy at any moment
• A flow variable measures a process that takes place over a period of time.
• Investment is a flow variable
• Depreciation is decrease in the value of assets
• As long as investment is greater than depreciation, total stock of capital will rise.
• The greater the flow of investment, the faster will be the rise in capital stock.
Saving and Investment
• Private saving
• Public saving
• Total saving = Private saving + Public saving
• In a closed economy,
The Loanable Funds Market
• Where households make their saving available to those who need additional funds
• Supply of loanable funds – household saving
• Demand of loanable funds – businesses and government
The Loanable Funds Market
• Businesses’ demand for loanable funds is equal to their planned investment spending (Ip)
• Funds obtained are borrowed, and firms pay interest on their loans
• Government’s demand for loanable funds
• Budget deficit (G – T)

Excess of government purchases over net taxes

• Government’s supply for loanable funds
• Budget surplus (T – G)

Excess of net taxes over government purchases

• Corporate profits tax
• A cut in tax on profits earned by corporations
• Investment tax credit
• A cut in taxes for firms that invest in certain favored types of capital
• Reducing business taxes or providing specific investment incentives can shift the investment curve (the demand curve in the loanable funds market) rightward
Targeting Households – Supply Side
• If households decide to save more of their incomes at any given interest rate
• Supply of loanable funds curve will shift rightward
• What might induce households to increase their saving?
• Greater uncertainty about economic future
• Increase in life expectancy
• Anticipation of an earlier retirement
• Change in tastes toward big-ticket items
• Change in attitude about saving
• Any of these changes—if they occurred in many households simultaneously—would shift saving curve to the right
• What can government do to increase household saving?
• One often-proposed idea is to decrease capital gains tax
Government’s Budget Deficit
• A increase in government purchases tends to raise interest rates.
• High interest rates discourage business investments.
• Crowding out effect
• So, to induce businesses to invest more, government should reduce its purchases.
• Shrinking deficit or rising surplus tends to reduce interest rates and increase investment.
• However, the effect on economic growth depends on how the budget changes.
Human Capital and Economic Growth
• Human capital
• Skills and knowledge possessed by workers
• An increase in human capital works like an increase in physical capital to increase output
• Causes production function to shift upward
• Raises productivity and increases average standard of living
• Human capital investments
• Education
Technology and Economic Growth
• Technological development is the key to sustaining economic growth
• The law of diminishing returns to capital
• Solow economic model
• Endogenous growth theory
• Technological change is not random but determined by factors in the market system.
• The principle that marginal cost equals marginal revenue in profit maximization applies in the determination of the amount of knowledge investment firms would like to make.
Technology and Economic Growth
• New technology affects economy in the way that it enables any given number of workers to produce more output.
• Production function shifts upward.
• Government policies that encourage investment in technology
• Protecting intellectual property rights
• Subsidizing research and development
• Subsidizing education
• Entrepreneurship