GROWTH, PRODUCTIVITY, AND THE WEALTH OF NATIONS Chapter 9.

GROWTH, PRODUCTIVITY, AND THE WEALTH OF NATIONS

Chapter 9Chapter 9

8-2

Fundamental Economic Goals

• Long-run – Focus is on how to increase potential output.

• Resource use• Technology

– Say’s Law: Supply creates its own demand • Related to Expenditure and Income approaches to GDP

• Short-run – Potential output is considered to be fixed– Focus is on how to get the economy operating at its

potential.

8-3

Growth Rates and Living Standards

• The Growth rate makes a huge difference in the long-run– Compounding– Rule of 72 – # years to double= 72/ growth rate.

• If China’s per capita income of $2000 grows 9% per year and the U.S. per capita income of $40,000 grows 1% per year– Time to double

• U.S. every 72 years• China every 8 years

– By 2055• U.S. per capita income about $65,000• China per capita income about $65,000

8-4

Effects of Growth

Price in minutes of work0 50 100 150 200

1919

Milk (½ gallon)Beef (1 pound)

Eggs (1 dozen)Bread (1 pound)

Chicken (3 lb. fryer)

2009Beef (1 pound)Eggs (1 dozen)Bread (1 pound)

Chicken (3 lb. fryer)

Milk (½ gallon)

8-5

Growth and Income Distribution

• A rising tide raises all ships

• Absolute vs. relative standards of living

• Is per capita income the right measure?– Means vs. medians– Income shares

8-6

Sources of Growth

• Specialization of Labor• Growth-compatible institutions• Investment and capital accumulation • Available resources• Technology• Entrepreneurship

Specialization of Labor

• The economics of pins• Modern mass production

8-8

Growth-Compatible Institutions

• Markets– Information

• Private ownership of property – The importance of incentives– The importance of limited liability--corporations

• The legal system– Fairness– Stability– Efficiency

8-9

Investment and Accumulated Capital

• A key element in growth

• Capital must be productive

• Capital is much more than machines. It includes:– Human capital – skills that workers gain from experience,

education, and on-the-job training.– Social capital – the habitual way of doing things that guides

people in how they approach production.

8-10

Available Resources

• The U.S. advantage

• Sustainability of resource use

8-11

Technology and Entrepreneurship • Waves of technology

– Industrialization – Railroads– Telecommunications– Air transportation– Computers– Bio-technology

• Impact of entrepreneurs– Watt– Whitney– Ford– Gates– Gore

8-12

Sources of Real U.S. Growth, 1928-2007

Human capital (13%)

Physical capital (19%)

Technology (35%)Labor (33%)

8-13

The Production Function

• Production function shows the relationship between inputs and outputs.

• Output = f(labor, capital, land)

• Growth is shown by a shift in the production function.

Q2

Q1

L1

The Economics of Gloom

THOMAS MALTHUS

8-15

Diminishing Marginal Productivity and Population Growth

Output

Labor

Subsistence level of output per worker

Production function

Q1

Q2

L1 L*

8-16

Diminishing Marginal Productivity and Technology/Capital

• Predictions of long-term catastrophe were wrong– Increases in technology and capital overwhelmed diminishing marginal

productivity of labor.

• Can it continue in a world of scarce natural resources?

8-17

Economic Policies to Encourage Growth

• Encouraging saving and investment.• Formalizing property rights and reducing

bureaucracy and corruption.• Providing more of the right kind of education.• Promoting policies that encourage technological

innovation.• Promoting policies that allow taking advantage of

specialization.

8-18

The Convergence Hypothesis• Convergence hypothesis – per capita income in

countries with similar institutional structures will converge

• Because:

– Costs of production are lower in other countries– Investment will flow to those countries

• Consequently:– U.S. growth will slow and growth rates in other countries will

increase

8-19

The Convergence Hypothesis

• As of the early 2000s the predictions of convergence have not come true.

• Because:– Lack of factor mobility– Differing institutional structure– Incomparable factors of production– Technological agglomeration effects– Learning by doing