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C hapter 24

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  1. Chapter 24 Long-Run Economic Growth and Business Cycles

  2. Economic Principles • Capital-labor and capital-output ratios • Technology and labor productivity • Labor productivity and economic growth • Saving, investment, and economic growth Gottheil - Principles of Economics, 4e

  3. Economic Principles • External and internal theories of the business cycle • The interaction of the multiplier and accelerator • Countercyclical fiscal policy Gottheil - Principles of Economics, 4e

  4. Long-Run Economic Growth Economic growth • An increase in real GDP, typically expressed as an annual rate of real GDP growth. Gottheil - Principles of Economics, 4e

  5. Long-Run Economic Growth In The Wealth of Nations, Adam Smith identified four principal factors that contribute to a nation’s economic growth. What are they? Gottheil - Principles of Economics, 4e

  6. Long-Run Economic Growth Principal factors that contribute to a nation’s economic growth: a. The size of its labor force Gottheil - Principles of Economics, 4e

  7. Long-Run Economic Growth Principal factors that contribute to a nation’s economic growth: a. The size of its labor force b. The degree of labor specialization Gottheil - Principles of Economics, 4e

  8. Long-Run Economic Growth Principal factors that contribute to a nation’s economic growth: a. The size of its labor force b. The degree of labor specialization c. The size of its capital stock Gottheil - Principles of Economics, 4e

  9. Long-Run Economic Growth Principal factors that contribute to a nation’s economic growth: a. The size of its labor force b. The degree of labor specialization c. The size of its capital stock d. The level of its technology Gottheil - Principles of Economics, 4e

  10. EXHIBIT 1 U.S. ECONOMIC PERFORMANCE: 1900–2000 Gottheil - Principles of Economics, 4e

  11. Exhibit 1: U.S. Economic Performance: 1900-2000 In what time period between 1900 and 2000 was there the greatest rate of economic growth in the U.S.? • During the first half of the 1940s when the U.S. was fighting World War II. Gottheil - Principles of Economics, 4e

  12. Long-Run Economic Growth Capital-labor ratio • The ratio of capital to labor, reflecting the quantity of capital used by each laborer in production. Gottheil - Principles of Economics, 4e

  13. EXHIBIT 2 LONG-RUN ECONOMIC GROWTH Gottheil - Principles of Economics, 4e

  14. Long-Run Economic Growth 2. If capital is $50,000 and labor is 200, what is the capital-labor ratio? • The capital-labor ratio is ($50,000/200) = $250. Gottheil - Principles of Economics, 4e

  15. Long-Run Economic Growth Labor productivity • The quantity of GDP produced per worker, typically measured in quantity of GDP per hour of labor. Gottheil - Principles of Economics, 4e

  16. Long-Run Economic Growth 3. If real GDP increases from $10,000 to $12,000, and labor rises from 100 to 105, what has happened to labor productivity? • Output per laborer rises from ($10,000)/100 = $100 to ($12,000)/105 = $114.29. Gottheil - Principles of Economics, 4e

  17. Long-Run Economic Growth Capital deepening • A rise in the ratio of capital to labor. Gottheil - Principles of Economics, 4e

  18. Long-Run Economic Growth 4. Which of the following represents capital deepening? a. Increased worker experience b. Increased worker training c. Increased capital-labor ratio Gottheil - Principles of Economics, 4e

  19. Long-Run Economic Growth 4. Which of the following represents capital deepening? a. Increased worker experience b. Increased worker training c. Increased capital-labor ratio Gottheil - Principles of Economics, 4e

  20. EXHIBIT 3 THE LABOR PRODUCTIVITY CURVE

  21. Exhibit 3: The Labor Productivity Curve How does capital deepening affect labor productivity? • The more capital per laborer, the greater the laborer’s productivity. Moreover, new technology can shift upwards the labor productivity curve. Gottheil - Principles of Economics, 4e

  22. Long-Run Economic Growth Capital-output ratio • The ratio of capital stock to GDP. Gottheil - Principles of Economics, 4e

  23. Long-Run Economic Growth According to Adam Smith and many economists today, savings automatically convert to investment spending, so that investment-induced growth is dependent on savings. Gottheil - Principles of Economics, 4e

  24. Long-Run Economic Growth Changes in technology can increase labor productivity and GDP without there being any change in the value of the capital stock. Gottheil - Principles of Economics, 4e

  25. EXHIBIT 4 THE GROWTH PROCESS Gottheil - Principles of Economics, 4e

  26. Exhibit 4: The Growth Process 1. According to Exhibit 4, what will happen to consumption and investment next year as a consequence of investment this year? • Investment this year increases next year’s capital stock, which in turn generates an increase in next year’s consumption and investment spending. Gottheil - Principles of Economics, 4e

  27. Exhibit 4: The Growth Process 2. What will happen to potential future economic growth if more of GDP is consumed and less is invested? • Less investment today means less economic growth in the future. Gottheil - Principles of Economics, 4e

  28. EXHIBIT 5 GROSS NATIONAL SAVING IN THE UNITED STATES: 1960–99 Source: Council of Economic Advisers, Economic Report of the President (Washington, D.C.: U.S. Government Printing Office, 2000), p. 73. Gottheil - Principles of Economics, 4e

  29. Exhibit 5: Gross National Savings in the United States: 1960-99 According to Exhibit 5, what is the relationship between personal savings and government savings? • It appears that they may be inversely proportional. Gottheil - Principles of Economics, 4e

  30. EXHIBIT 6 SOURCES OF US. GROWTH: 1947–2003 Source: Council of Economic Advisers, Economic Report of the President (Washington, D.C.: U.S. Government Printing Office, 1994), p. 44, and author’s estimates. Gottheil - Principles of Economics, 4e

  31. Exhibit 6: Sources of U.S. Growth: 1947-2003 1. According to Exhibit 6, which of the following made the largest contribution to economic growth from 1947 to 1973: a. Labor inputs b. Capital inputs c. Technological change Gottheil - Principles of Economics, 4e

  32. Exhibit 6: Sources of U.S. Growth: 1947-2003 1. According to Exhibit 6, which of the following made the largest contribution to economic growth from 1947 to 1973: a. Labor inputs b. Capital inputs c. Technological change Gottheil - Principles of Economics, 4e

  33. Exhibit 5: Sources of U.S. Growth: 1947-2003 2. According to Exhibit 6, which of the following made the largest contribution to economic growth from 1973 to 1992: a. Labor inputs b. Capital inputs c. Technological change Gottheil - Principles of Economics, 4e

  34. Exhibit 6: Sources of U.S. Growth: 1947-2003 2. According to Exhibit 6, which of the following made the largest contribution to economic growth from 1973 to 1992: a. Labor inputs b. Capital inputs c. Technological change Gottheil - Principles of Economics, 4e

  35. Exhibit 6: Sources of U.S. Growth: 1947-2003 3. According to Exhibit 6, what happened to the role of technological change as a source of U.S. economic growth across the two time periods? • While technological change was the most important source of economic growth from 1947 to 1973, it was one of the smallest and least important sources of economic growth between 1973 and 1992. Gottheil - Principles of Economics, 4e

  36. The Business Cycle The business cycle represents year to year deviations from the dominant, long-run path of U.S. economic growth. These deviations seem to map out a picture of recurring cycles. Gottheil - Principles of Economics, 4e

  37. EXHIBIT 7 THE U.S. BUSINESS CYCLE RECORD: 1860–1990 Source: Ameritrust Company, Cleveland, Ohio. Gottheil - Principles of Economics, 4e

  38. Exhibit 7: The U.S. Business Cycle Record: 1860-1990 1. According to Exhibit 7, were recessions more frequent before World War II or after World War II? • Recessions were more frequent before World War II. Gottheil - Principles of Economics, 4e

  39. Exhibit 7: The U.S. Business Cycle Record: 1860-1990 2. In which of the following decades was there the greatest period of rapid and prolonged economic growth in Exhibit 6? a. 1870 – 1880 b. 1930 – 1940 c. 1960 – 1970

  40. Exhibit 7: The U.S. Business Cycle Record: 1860-1990 2. In which of the following decades was there the greatest period of rapid and prolonged economic growth in Exhibit 6? a. 1870 – 1880 b. 1930 – 1940 c. 1960 – 1970 Gottheil - Principles of Economics, 4e

  41. Traditional Theories of the Business Cycle 1. What factors contribute to externally induced cycles? • Wars, changes in climate, population booms, clustering of innovations, changes in consumer confidence, changes in government spending, or changes in international exchange rates. Gottheil - Principles of Economics, 4e

  42. Traditional Theories of the Business Cycle 2. What is the sunspot theory of the business cycle? • According to William Stanley Jevons, years of good harvest, low food prices, and higher real income and employment, are inversely related to the number of sunspots. Gottheil - Principles of Economics, 4e

  43. Traditional Theories of the Business Cycle 2. What is the sunspot theory of the business cycle? • The sunspot theory mostly applies to agricultural economies, and is less relevant to modern industrialized countries. Gottheil - Principles of Economics, 4e

  44. Traditional Theories of the Business Cycle 3. What is the war-induced theory of the business cycle? • Wars require massive increases in government spending, which tends to increase economic growth. Marxists and others have argued that wars are sometimes engineered to get us out of economic crises. Gottheil - Principles of Economics, 4e

  45. Traditional Theories of the Business Cycle 3. What is the war-induced theory of the business cycle? • The decline in spending at the end of wars can contribute to economic downturns. Gottheil - Principles of Economics, 4e

  46. Traditional Theories of the Business Cycle 4. What is the housing theory of the business cycle? • Disasters or low interest rates spur large investments in new housing, which in turn promotes increased economic growth. As housing investment slows, so too does economic growth. Gottheil - Principles of Economics, 4e

  47. Traditional Theories of the Business Cycle 5. What is the innovation theory of the business cycle? • Pioneering innovations promote a host of supporting innovations in clusters, and thus produce their own variety of business cycle. Steam engines, railroads, electricity, cars, and computers offer some examples. Gottheil - Principles of Economics, 4e

  48. Traditional Theories of the Business Cycle 5. What is the innovation theory of the business cycle? • Yet even pioneering innovations eventually exhaust their potential, creating the potential for reduced investment, demand, and employment. Gottheil - Principles of Economics, 4e

  49. Traditional Theories of the Business Cycle • Many economists believe that business cycles do not just develop from external factors. • According to this view, the economy’s continuous motion is inherently cyclical due to internal factors. Gottheil - Principles of Economics, 4e

  50. Traditional Theories of the Business Cycle 6. What factors contribute to internally induced business cycles? • Changes in investment spending and changes in national income are mutually reinforcing due to the role of expectations. Gottheil - Principles of Economics, 4e