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Economic Growth

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  1. Economic Growth Chapter 10

  2. Basics of Economic Growth • How to calculate growth rate • Growth rate of real GDP = (real GDP in current year – real GDP in previous yea) / real GDP in previous year * 100 • Growth rate of real GDP per capita = growth rate of real GDP – growth rate of population • Rule of 70 • The number of years it takes for the level of any variable to double is approximately 70 divided by the annual growth rate of the variable

  3. Sources of Economic Growth • Sources • Increase in labor (aggregate hours) • Physical capital growth • Human capital growth • Technology advance • The last three sources contribute to economic growth through labor productivity • Labor productivity = real GDP / aggregate hours

  4. Sources of Economic GrowthContinued • Productivity curve • Relationship between labor productivity (real GDP per hour of labor) and the amount of physical per hour of labor • Movement along the productivity curve is caused by changes in capital per hour of labor. • One third rule: 1% capital increase  1/3 % labor productivity • Shift of the productivity curve is caused by changes in human capital and technological advance. • Why lower labor productivity growth in the 1970s?

  5. Theories of Economic Growth • Classical growth theory • A pessimistic view that an exploding population and limited resources will eventually bring economic growth to an end. • Also called Malthusian theory • Process • Initially economic growth from subsistence level with more capital and technology advance  population growth and no more resources push the economy back to the subsistence level • Background: population explosion of 18th c. Europe

  6. Theories of Economic GrowthContinued • Neoclassical growth theory • Population growth and technology advance will affect economic growth, but as long as technology keeps advancing, the economy will grow. • Technology advance is exogenous (a result of chance). • Background: no more population explosion in the 19th and 20th c. • Shortcoming: no explanation of how technology advances.

  7. Theories of Economic GrowthContinued • New growth theory • Our unlimited wants will lead us to ever greater productivity and perpetual economic growth. • Our choices and preference for better living and profits lead us new discoveries and accumulation of human capital. • Competition squeeze profits  seeking new discoveries • Continuous shift up of the productivity curve

  8. Preconditions for Economic Growth • Preconditions: Economic freedom • Freedom of individuals and businesses from government restraints on economic activities • Legal and institutional frameworks to safeguard economic freedom (such as property rights and contract laws) • Visit www.heritage.org for ranking of individual countries.

  9. Policies to Achieve Economic Growth • Create the incentive mechanisms • Promote competition • Promote international trade • Encourage saving • Encourage investment, particularly R & D. • Improve quality of education and training