CHAPTER 17: ECONOMIC GROWTH

INGREDIENTS OF GROWTH

• Supply Factors – changes in the physical and technical agents of production – enable an economy to expand it potential GDP.

·         Increases in the quantity and quality of natural resources

·         Increases in the quantity and quality of human resources

·         Increases in supply of capital goods

·         Improvements in technology

• Demand factor – fifth ingredient of economic growth.

·         To achieve the higher production potential created by supply factors, households, businesses and government must purchase the economy’s expanding output of goods and services.

• Efficiency Factor – sixth ingredient of economic growth.

·         To reach its production potential, an economy must achieve an economic efficiency as well as full employment. The economy must use its resources in the least costly way to produce the specific unit of goods and services that maximizes people’s well being.

• Production Possibilities Analysis

·         Growth and Production Possibilities

It indicates the various maximum combinations of products an economy can produce with its fixed quantity and quality of natural, human and capital resources and its stock of technological knowledge. An improvement in any of the supply factors will push the production possibilities curve outward.

“best allocation” – is determined by expanding production of each good until its marginal benefit equals its marginal cost.

·         Labor and Productivity

REAL GDP = hours of work x labor productivity

-Hours of work – hours of labor input depend on the size of the employed labor force and the length of the average workweek. Labor force size depends on the size of the working-age population and the labor-force participation rate – the percentage of the working-age population actually in the labor force.

-Labor productivity – is determined by technological process, the quantity of capital goods available to workers, the quality of the labor itself, and the efficiency with which inputs are allocated, combined and managed.

•  Growth in the AD-AS Model

·         Production Possibilities and Aggregate Supply

The supply factors that shift the production possibilities curve outward also shift its long-run aggregate supply curve rightward.

·         Extended AD-AS Model

It is used to depict the economic growth process. It is extended to include the distinction between short- and long-run aggregate supply.

U.S. ECONOMIC GROWTH RATE

Over the full 50 years, real GDP grew by about 3.5% annually, whereas real GDP per capita grew by about 2.3% annually.

ACCOUNTING FOR GROWTH

Growth Accounting – bookkeeping of the supply side elements that contribute to changes in real GDP – to assess the factors underlying economic growth.

2 main categories:

·         Increases in hours of work

·         Increases in labor productivity

• Labor inputs versus Productivity

Both increases in the quantity of labor and rises in labor productivity are important source of economic growth.

• Technological Advance

It includes not only innovative production techniques but new managerial methods and new forms of business organization that improve the process of production.

• Quantity of Capital

Increased capital explains roughly 30% of productivity growth.

• Education and Training

Contribute to a worker’s stock of human capital – the knowledge and skills that make a productive worker.

•  Economies of Scale and Resource Allocation

·         Economies of Scale – reductions in per-unit cost that result in the size of markets and firms.

·         Improved Resource Allocation – means that workers over time have moved from low-productivity employment to high-productivity employment.

• Other Factors

·         Reliance on the market system

·         A stable political system

·         A social philosophy that embraces material progress

·         An abundant supply of willing workers and entrepreneurs

·         Free-trade policies

THE PRODUCTIVITY ACCELERATION: ANEW ECONOMY?

New economy – one with a higher projected trend rate of productivity growth and therefore greater potential economic growth than the 1973-1995 period.

• Reasons for the Productivity Acceleration

·         The Microchip and Information Technology

Microchip – it has helped create a wide array of the products and services and new ways of doing business.

Information Technology – connect all parts of the world.

·         New Firms and Increasing Returns

Start-up Firms – advanced various aspects of the new information technology.

Increasing Returns – occur when a firm’s output increases by a larger percentage than the increase in its inputs. There are a number of sources of increasing returns and economies of scale for emerging firms:

-More specialized inputs

-Spreading of development costs

-Simultaneous consumption

-Network effects

-Learning by doing

·         Global Competition

• Macroeconomic Implications

·         More rapid economic growth

The productivity speedup allows the economy to achieve a higher rate of economic growth.

·         Law Natural Rate of Unemployment

A law natural rate of unemployment (NRU) such that of 1995-2000 (4-5%) may also be consisted with the new economy.

·         Growing Tax Revenue

The faster economic growth enabled by the productivity speedup produces larger increases in personal income and, given tax rates, larger increases in government tax revenues.

• Skepticism about Performance

Skeptics of the New Economy urge a wait-and-sec approach. They point out that surges in productivity and real GDP growth rate have previously occurred during vigorous economic expansions but do not necessarily represent long-lived trends.

IS GROWTH DESIRABLE AND SUSTAINABLE?

• The Antigrowth View

Critics of rapid growth say that it adds to environmental degradation, increases human stress, and exhausts the earth’s finite supply of natural resources.