Frank & Bernanke

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Frank & Bernanke. Ch. 8: Economic Growth, Productivity, and Living Standards. Source: http://www.economist.com/displayStory.cfm?story\_id=346598. Source: http://hdr.undp.org/reports/global/2002/en/indicator/indicator.cfm?File=indic\_290\_1\_1.html. http://hdr.undp.org/statistics/highlights/.

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### Frank & Bernanke

Ch. 8: Economic Growth, Productivity, and Living Standards

Source: http://www.economist.com/displayStory.cfm?story_id=346598
Source: http://hdr.undp.org/reports/global/2002/en/indicator/indicator.cfm?File=indic_290_1_1.html

http://hdr.undp.org/statistics/highlights/

Compound Interest
• Suppose you put \$100 in a savings account for your retirement. How much would you have in 50 years?
• You need to know the interest rate.
• At 1%, the savings at the end of one year will be: 100 + 100*.01 = 100 (1+.01) = 101.
• At the end of two years, the savings will be: 100(1.01) + 100(1.01)(.01) = 100(1.01)(1.01) = 100 (1.01)2
Impact on Living Standards
• GDP per capita grew at a rate of 2% per year for US during the last 50 years.
• Japanese GDP per capita grew at a rate of 5% during the same period.
• Chinese GDP per capita grew about 8% per year the last twenty years.
Real GDP per Capita
• Real GDP per capita is found by dividing the Real GDP by the population: Y/POP.
• We can rewrite Y/POP as Y/N times N/POP, since the Ns would cancel out when the two terms are multiplied.
• Y/N is average labor productivity.
• N/POP is employed portion of the population.
Growth Rate of Y/POP
• Percentage growth of Y/POP will be equal to percentage growth of Y/N (Average Labor Productivity) PLUS N/POP (Share of population employed).
• We can get these numbers for US from government web sites: Bureau of Labor Statistics, Bureau of Economic Analysis, Federal Reserve Bank of St. Louis.
US Experience and Forecast
• Why did N/POP increase during the last 30 years?
• What is expected for the future of N/POP?
• How can US expect to raise average living standards in the future?
Determinants of Average Labor Productivity
• Human Capital
• Physical Capital
• Natural Resources
• Technology
• Entrepreneurship and Management
• Political and Legal Environment
Human Capital
• Human capital of workers includes the
• Talents
• Education
• Training
• Skills
Physical Capital
• Quantity and quality of machines, tools, equipment and buildings affect the productivity of labor.
• How productive is a computer programmer without a computer?
• Using MB vs. MC principle to allocate machinery.
• Diminishing returns reduces the MB for the next machine.
Natural Resources
• Abundant land, energy, raw materials will allow inputs to be cheap for producing certain products, giving a country comparative advantage in these products.
• Free trade practically frees a country from the yoke of lack of natural resources.
Technology
• New technologies that increase the productivity of labor is commonplace in our age.
• New ways of organizing, presenting, sequencing, etc. are also considered technological advances.
• Technological improvements in one area may have positive spillover effects in another industry.
Entrepreneurship and Management
• Entrepreneurs take risks to introduce new products, new processes into the economy.
• Societies that provide secure property rights, low and predictable taxation and independent, incorruptible legal system support the flourishing of entrepreneurial activity. (See M. Olson, Power and Prosperity.)
Entrepreneurship and Management
• China in the Middle Ages was far superior to the West technologically. However, the social system stifled economic growth: application of technology to production.
• Management is every day operation of the establishment. Education is supposed to reduce the incidences of wrong decisions in everyday operations.
Political and Legal Environment
• It is the function of the government to provide an environment where individuals and firms are not subjected to arbitrary rules, increasing the uncertainty of efforts.
• Enforceable contracts, well-defined property rights, political and social environment conducive to taking risks in production are responsibilities of governments.
• Soviet example.
Worldwide Productivity Slowdown
• Starting with 1973, industrialized nation experienced a significant productivity slowdown.
• Slow growth brings social problems.
• Redistribution can exacerbate these problems.
Why Did Productivity Slow Down?
• Decline in public education?
• Oil price shocks?
• Poor measurement of productivity gains in service sector?
• The exceptional experience of the 50s and 60s?
Costs of Economic Growth
• Resources allocated to capital formation will reduce production of consumer goods.
• Unsanitary, unsafe conditions for industrial workers (historical for US, current for many LDCs).
• Is the sacrifice today, worth better living conditions tomorrow?
How to Increase Growth Rates?
• The factors that determine average labor productivity may be enhanced by public policy.
Policies to Increase Human Capital
• Education increases human capital.
• Why does the government provide “free” K-12 education?
• Positive externalities: Private demand does not capture all the societal benefits.
• Who should decide the content of curriculum?
Policies to Promote Saving and Investment
• Capital stock in a country increases through investment activities.
• Investments require resources diverted from consumption goods to capital goods.
• If consumers do not restrict their consumption (if they don’t save) total expenditures will exceed the value of production and inflation will ensue.
Policies to Promote Saving and Investment
• High rates of saving allow a country to channel resources into capital formation.
• Governments can pass laws to promote saving and laws to promote investment.
• Governments also can create capital stock directly (how does it pay?)
Policies to Support R&D
• Public good aspect of knowledge reduces private investment in knowledge.
• Collective decision-making is required for activities with higher social benefits than individual benefits, e.g. basic research.
Legal and Political Framework
• Political stability
• Free and open exchange of ideas
• Secure property rights
• Well functioning legal system
• Free markets (except for those with significant externalities)
Limits to Growth?
• Will we run out of oil (natural resources)?
• Market mechanisms: price incentives
• Will we spoil the environment completely?
• Change in tastes and preferences
• Can we solve the global warming problem?
• Limits to collective decision-making.
Commodity Prices

FIRST published in 1864, with figures stretching back to 1845, The Economist's commodity-price index is probably the world's oldest regularly published price index. Since October 2001, our dollar-based industrials index has risen by 76%, fuelled by Chinese demand for raw materials and, in part, the weakness of the dollar. Yet in real terms, industrial commodity prices are a mere 30% of their value in 1845

http://www.economist.com/printedition/displayStory.cfm?Story_ID=3651836