Economic Growth Economic Growth, in general, means increase in economic (material) well being of average citizen.

Economic Growth

Economic Growth, in general, means increase in economic (material) well being of average citizen.

Economic Growth

Economic Growth, in general, means increase in economic (material) well being of average citizen. It is measured as the rate of change in the real per capita income (real GDP).

Economic Growth

Economic Growth, in general, means increase in economic (material) well being of average citizen. It is measured as the rate of change in the per capita

income (GDP). That is to say, if a nation’s output of goods and services outpace population growth, average real per capita income will increase and therefore, average individual will be materially better off than before.

Economic Growth

Measuring economic growth is problematic because:

• data problem (collection frequencies, accuracy)

Economic Growth



• distribution of the GDP

Economic Growth




• better living standard? (work v. leisure)

Economic Growth




• better living standard? (work v. leisure)

• Quality improvement

Short v. Long Run

Short run is defined as a period short enough that labor is the only factor that could be increased to raise output.

N

y Y=f(N)

Short v. Long RunLong run is defined as a period long enough

that we can change the capacity of production. In this case, K and L as productivity become determining factors in economic growth.

N

y Y=f(N, K) * A

Determinants of Growth

Economic growth could result from:

• increase in supply of labor



• increase in supply of labor• population growth




• immigration




• immigration

• increase in capital stock




• immigration

• increase in capital stock

• increase in productivity

Increase in Supply of labor

y y

y

y

W

N

N

F(N)


y y

y

y

W

N

N

F(N)


y y

y

y

W

N

N

F(N)

Increase in labor productivity

y y

y

y

W

N

N

F(N)


y y

y

y

W

N

N

F(N)F’(N)


yy

y

y

W

N

N

F(N)F’(N)

WW’

N N’ y y’

yy’

Capital and Investment

Capital is the total quantity of plant, equipment, buildings, and inventories.

Gross investment is the purchase of new capital.


Depreciation is the wearing out and scrapping of existing capital.

Net investment is gross investment minus depreciation.


Private investment is business investment plus investment in new homes and addition to inventories.

Government investment is the part of government purchases that creates social infrastructure capital.

Investment and the Capital Stock: 1970–1998

Investment and the Capital Stock: 1970–1998

Investment in the United Statesand World: 1970–1998

Investment Decisions

Business investment decisions are influenced by:

1) The expected profit rate

2) The real interest rate


The Expected Profit RateThe greater the expected profit rate from new capital, the greater is the amount of investment.


The Expected Profit RateThree Major Factors Affecting the Expected Profit Rate

1) The phase of the business cycle affect expected rates of profits: In recessions sales and profits fall while during expansions

sales and profits rise. Therefore, during recessions (expansions) investment demand falls (rises)

2) Advances in technology

3) Taxes

The Real Interest Rate


The Real Interest Rate– The opportunity cost of funds is the real interest

rate.


The Real Interest Rate– The opportunity cost of funds is the real interest rate

– The lower the real interest rate, the greater is the amount of investment..


The Real Interest Rate– The lower the real interest rate, the greater is the amount of investment.

– The opportunity cost of funds is the real interest rate.

– If the real interest rate exceeds the expected profit rate, firms should not invest in new capital since they could earn more by loaning the funds to other firms.


Investment DemandIllustrates the relationship between investment and the real interest rate.

ID

Investment Demand

Investment (trillions of 1992 dollars)

Rea

l int

eres

t rat

e (p

erce

nt p

er y

ear)

2

4

6

8

10

12

0 0.6 1.0 1.2 1.4 1.6

a

c

b

A rise in thereal interestrate decreasesinvestment

A fall in thereal interestrate increasesinvestment

0.8

Investment Demand

Investment (trillions of 1992 dollars)

Rea

l int

eres

t rat

e (p

erce

nt p

er y

ear)

2

4

6

8

10

12

0 0.6 0.8 1.0 1.2 1.4 1.6

ID0

ID1

ID2

An increase in theexpected profit rateincreases investmentdemand

A decrease in theexpected profit ratedecreases investmentdemand

Investment Demandin the United States

Recession of 1991

Expansion of 1990s

Saving Decisions

National SavingThe sum of private saving and government saving.

Saving Decisions

The main factors affecting household saving are:

– The real interest rateThe lower the real interest rate, the smaller is the

amount of saving and the greater is the amount of consumption.

Saving Decisions

The main factors affecting household saving are:– The real interest rate

The lower the real interest rate, the smaller is the amount of saving and the greater is the amount of consumption.

– Disposable incomeThe greater a household's disposable income the

greater is its saving.

Saving Decisions



– Disposable incomeThe greater a household's disposable income the greater is its saving.

– Purchasing power of net assets• The greater the purchasing power of a

household’s net assets the less is its saving.• Net assets are assets minus debts

Saving Decisions



– Disposable incomeThe greater a household's disposable income the greater is its saving.

– Purchasing power of net assets• The greater the purchasing power of a household’s net assets the less is its

saving.• Net assets are assets minus debts

– Expected future income• The lower a household’s expected future income the greater is

its saving.

Saving DecisionsSaving Supply

Illustrates the relationship between saving and the real interest rate

SS

Saving Supply

Saving (trillions of 1992 dollars)

Rea

l int

e res

t rat

e (p

erce

nt p

er y

ear)

4

6

8

10

12

0 0.8 0.9 1.0 1.1 1.2 1.3

a

b

c

A fall in the real interestrate decreasessaving

A rise in the real interestrate increasessaving

2

Saving Supply

Saving (trillions of 1992 dollars)

SS0

Rea

l int

eres

t rat

e (p

erce

nt p

er y

ear)

4

6

8

10

12

0 0.8 0.9 1.0 1.1 1.2 1.3

An increasein saving supply

A decreasein saving supply

2

SS1

SS2

Saving Supply in theUnited States: 1970–1998

Saving and Investment inthe National Economy

• Saving supply and investment demand in the world economy determine the world real interest rate.

• Saving does not necessarily equal investment in a national economy.


• National investment is financed by national saving plus borrowing from the rest of the world.

• For the world as a whole, international borrowing equals international lending.


• Each nation contributes to world saving and investment and so influences the world real interest rate.

• A nation’s saving and investment decisions, along with the world real interest rate, determine the amount the nation borrows from or lends to the rest of the world.

Saving, Investment, andInternational Borrowing

Investment and saving (trillions of 1992 dollars)

Rea

l int

eres

t rat

e (p

erce

nt p

er y

ear)

4

6

8

10

12

0 0.5 1.0 1.5 2.0

2

SS

ID

Worldreal interestrate

Internationalborrowing

Economic Growth Economic Growth, in general, means increase in economic (material) well being of average citizen.

Documents

supply of labor slide

productivity slide

gdp slide

accuracy slide

economic material

leisure slide

capital stock slide

capital stock increase