economics 285

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Economics 285Economics 285Economic

GrowthI.B.M. Will Invest $5 Billion ToProduce Newer Microchips – NY Times 10/10/2000

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Economic GrowthEconomic Growth

Long-Term Growth TrendsThe Sources of Economic GrowthGrowth AccountingGrowth TheoryAchieving Faster Growth

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Long-term growth trends are the trends in potential GDP

Long-Term Growth TrendsLong-Term Growth Trends

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A Hundred Years of Economic A Hundred Years of Economic Growth in the United StatesGrowth in the United States

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Economic Growth in CanadaEconomic Growth in CanadaFigure shows long-term growth in Canada since 1895.

Growth was fastest during the 1960s.

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Fig. 11.2(a) shows growth in the biggest economies since 1960.

Japan has caught up with the other big economies.


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Fig. 11.2(b) shows gaps in real GDP per person have been very persistent for most groups of countries.


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Fig. 11.3 shows some Asian economies closing the gap in real GDP per person.


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Economic growth occurs when incentives are created by: markets property rights monetary exchange

The Sources of Economic The Sources of Economic Growth Growth

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The activities that generate growth are: saving and investment growth of human capital discovery of new technologies

The Sources of Economic The Sources of Economic Growth Growth

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Growth accounting is the attempt to measure the contributions to growth of labor, capital, and technological change.

Real GDP growth equals the growth of real GDP per hour of work plus the growth rate of aggregate hours.

Growth AccountingGrowth Accounting

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The growth rate of real GDP per hour of work depends on: Growth of capital per hour of labor Technological change

Fig 11.4 is a time series plot of GDP per hour of work for US


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Real GDP per Hour of WorkReal GDP per Hour of Work

Fig 11.4 -- time series plot of GDP per hour of work for US

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Separates the effects of: Growth of capital per hour of labor Technological change

Hold technology constant, vary capital per hour of work

Productivity functionProductivity function

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How Productivity GrowsHow Productivity Grows

20

32

25

30 60

PF0

PF0

Effect of technologicalchange

Effect ofincreasein capitalstock

Rea

l GD

P p

er h

our

of w

ork

(199

2 do

llars

)

Capital per hour of work (1992 dollars)

0

Fig. 11.5

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One-third rule. Goal: Divide the increase in real GDP per hour of work into capital effect technological

change effect


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An x percent increase in capital per hour of work brings a 1/3 of x percent increase in output per hour of work.


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The remaining increase in output per hour of work is attributed to technological change (and unidentified factors).


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Growth accounting is used to account for the productivity growth slowdown.

Figure 11.6 shows how this type of breakdown is made.


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Growth Accounting and the Growth Accounting and the Productivity Growth SlowdownProductivity Growth Slowdown

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Technological Change During the Productivity Growth Slowdown Technology was directed toward coping

with two major problems.

1) Energy price shocks

2) The environment

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Achieving Faster Growth Stimulate Saving Encourage international trade Improve the quality of education Stimulate high-technology industries? Target high-technology industries?

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The task of growth theory is to explain the trends in economic growth.

Three main theories have been proposed: Classical growth theory Neoclassical growth theory New growth theory

Growth TheoryGrowth Theory

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Classical Growth TheoryClassical Growth Theory

Real GDP growth is temporary Real GDP per person above subsistence Brings population explosion Returns real GDP per person back to the

subsistence level. Malthusian theory.

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The Basic Idea (1776) Real GDP has increased Real wage rate has increased Population growth increases labor supply Wage falls due to diminishing returns...

... to labor

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Subsistence real wage rate

Minimum needed to maintain life. If the real wage rate falls below

subsistence, some people cannot survive and population growth subsides

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LD1

Growth BeginsGrowth Begins

1

2

3

4

5

0 1 2 3 4 5 6

LS0

LD0

Labor (millions)

Rea

l wag

e ra

te (

1776

shi

lling

s pe

r da

y)New technologies andmore capital increasethe productivity of labor

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Subsistencereal wage rate

A Dismal OutcomeA Dismal Outcome

1

2

3

4

5

0 1 2 3 4 5 6

LS0 LS1

LD1

Labor (millions)

Rea

l wag

e ra

te (

1776

shi

lling

s pe

r da

y)

When the real wagerate exceeds thesubsistence level, thepopulation increases

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Modern Theory ofModern Theory ofPopulation GrowthPopulation Growth

Income levels and population growth may be inversely related Opposite of Malthus Income death rate falls Income birth rate falls

Relationship is weak

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Neoclassical Growth TheoryNeoclassical Growth Theory

Technological change

Induces saving and investment

Makes capital per person grow

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The Basic Idea Technological advances promise new profit

opportunities ID increases, real interest rate rises Saving increases K stock grows Real GDP and YD grow

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The Basic Idea (cont.) Prosperity will persist Growth will stop if technology stops

advancing:• profit leads to K accumulation• diminishing returns to capital

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Target Rate and Long-Run Saving When real interest rate exceeds the target

rate, the K stock increases When the target rate exceeds real interest

rate, the K stock decreases When real interest rate = the target rate,

the K stock is constant

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Target Rate and Long-Run Saving (cont.) Technology advances, real GDP grows but

the growth rate diminishes New advances increase the demand for

capital, raising the real interest rate and inducing saving

Rate of technological progress is unpredictable

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Target Rate and Long-Run Saving (cont.) The process repeats as long as technology

advances, creating an on-going process of long-term economic growth.

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A contradicted hypothesis? Technology and capital are mobile Therefore growth rates and per-capita

income levels converge Data reveal that convergence is slow or

absent

Why?

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ID1

Neoclassical Growth BeginsNeoclassical Growth Begins

Savings and investment (trillions of 1992 dollars)

Rea

l int

eres

t rat

e (p

erce

nt p

er y

ear)

2

4

6

8

0 0.5 1.0 1.5 2.0 2.5

SS0

ID0

10

Technologicaladvances increaseinvestment demand...

…real interestrate, saving, andinvestment increase

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KD1

KS1

Neoclassical Growth EndsNeoclassical Growth Ends

2

4

6

8

0 5 10 15 20 25

KS0

KD0

10

Capital stock (trillions of 1992 dollars)

Rea

l int

eres

t rat

e (p

erce

nt p

er y

ear)

LKSa b

When the real interestrate exceeds the target rate, saving and investment increase thesupply of capital.

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New Growth TheoryNew Growth Theory

Holds that real GDP per person grows because of the choices that people make in the pursuit of profit and that growth can persist indefinitely.

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New growth theory begins with two facts about market economies:

1) Discoveries result from choices.

2) Discoveries bring profit, and competition destroys profit.

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Discoveries and Choices The pace of discoveries is not determined

by chance. It depends on how many people are

looking for a new technology and how intensively they are looking.

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Two other facts are key to new growth theory:

1) Discoveries can be used by many people at the same time.

2) Physical activities can be replicated.

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2

4

6

8

0 1 2 3 4 5

KS0

10

Capital (trillions of 1992 dollars)

Rea

l int

eres

t rat

e (p

erce

nt p

er y

ear)

LKS

KD0

KD1

KS1 KS2 KS3

a

economics 285

Documents

growth of capital

growth trendsreal gdp

shows growth

growth of real gdp

growth of labor

growth accountingone

years of economic growth

longterm growth trendsfig