Transcript ECONOMICS - TerpConnect

CHAPTER
Chapter 9
Economic Growth
and Rising Living Standards
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Why is Economic Growth Important?
• Economic growth means rising living
standards measured as growth in real
GDP per person (per capita).
• Real GDP per capita =
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛
• Higher real income/GDP per capita
associated with a higher quality of life
• Real per capita is not a perfect measure.
– want to consider items such as education,
environment, good health, leisure time
– distribution of income
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High Quality of Life in Wealthy Countries Goes Beyond GDP
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Importance of Economic Growth
• Small differences in GDP growth rate
matter a lot over time
• The rule of 70
– if a variable is growing by X percent per
year it will double in approximately 70 / X
years
– 70/2 = 35 years (2% growth per year)
– 70/4 = 17.5 years (4% growth per year)
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Meaning and Importance of Economic Growth
• US real GDP per capita in 2013 was
$50,000
• At 2% annual growth, this will grow to
$50,000(1.02)20 =$74,300 in 20 years
• At 3% annual growth, this will grow to
$50,000(1.03)20 =$90,300 in 20 years
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How about investment returns?
• Suppose you have $50,000 to invest • At 2% annual growth, say in a savings
account, this will grow to $50,000(1.02)20
=$74,300 in 20 years
• At 7%, in the stock market,
$50,000(1.07)20 =$193,480 in 20 years
• Growth rates matter!
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Importance of Economic Growth
• A country that was once poor can become
rich
– Late 1960s: South Korea and Singapore
began growing rapidly
– 1980s: China and India started experiencing
economic growth
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What Makes Economies Grow?
Four things:
1. Labor productivity – output per hour
– total output divided by total hours worked
2. Average number of hours per worker
– total hours divided by total employment
3. Fraction of the Population that is working.
•
The Employment–population ratio (EPR)
• Total employment divided by total population
4. The size of the population
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What Makes Economies Grow?
Total Output (Real GDP) Here’s why!
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Growth Equation
• Percentage growth rate of real GDP per capita is
the sum of the growth rates of productivity, average
hours, and the employment-population ratio
Real GDP = Productivity  Average Hours  EPR  Population
Real GDP
=Productivity × Average Hours × EPR
Population
% Real GDP per capita  %Δ Productivity + %Δ Average Hours +
+ %Δ EPR
•An increase in any of the variables on the
right will create a rise in living standards
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Factors Contributing to Growth in U.S. Real
GDP Per Capita
•They are not equally important
•Average hours has not been an important
determinant of growth
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Growth in the EPR
• Employment-population ratio, EPR,
increases when total employment rises at
a faster rate than the population
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Growth in the EPR
• Causes for total employment to increase
– increase in labor supply
– increase in labor demand
• Increase in labor supply
– higher employment, higher EPR for a
given population
– equilibrium real wage drops
– higher GDP
• Higher real GDP per capita (for a given
population)
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An Increase in Labor Supply
Real
Hourly
Wage
L1S
A
At point A, labor supply and
demand determine an employment
level of 150 million workers.
L2S
$25
An increase in labor supply raises
employment to 180 million (at point
B) although with a lower wage rate.
B
$20
LD
150
Real
Output
$11.5 trillion
$10 trillion
180
Millions of Workers
F
E
With more people working, real
GDP rises from $10 trillion to
$11.5 trillion.
150
180
Millions of Workers
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Growth in the EPR
• Increase in labor demand
– demand curve shifts to the right
– higher employment
– equilibrium wage rate increases
– higher GDP
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An Increase in Labor Demand
Real
Hourly
Wage
LS
B
$28
$25
If firms demand more labor,
employment will increase—
from 150 million to 180
million—while the wage rate
rises
A
L2D
L1D
150
180
Millions of Workers
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Can Government Policy increase Employment?
• Implement policies to increase the growth of
labor supply
• Implement policies to increase the growth of
labor demand
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Policies to Increase the Growth of Labor Supply
• Decrease income tax rates (marginal
tax rate)
– Increase take home pay of workers.
– Do people want to work more and do more
people want to work if take home pay increases?
– This is a Big Question!
– Marginal tax rate, tax paid on each extra dollar
earned.
– if effective, this policy would shift the labor
supply curve to the right => total output (GDP)
increases
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Policies to Increase the Growth of Labor Supply
• Cut government benefit programs
– Do benefit programs such as
unemployment insurance and welfare
payment create disincentives to work?
– European countries have cut benefit
programs
– Clinton administration reform of welfare
programs
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Policies to Increase the Growth of Labor Demand
• Increase worker productivity
– Training and education
• Subsidize employment
– Tax benefit to employers
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Growth in Employment - the EPR
• But, government policy can increase EPR
only temporarily – one shot impact.
• Significant, sustained economic growth
requires significant, sustained growth in
the EPR (look at the Growth Equation)
which is not realistic.
• look at the trends
• 100% is the upper bound
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EPR: 1950 - 2014
1995-08
1973-95
1953-73
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Rising Productivity is the Most Important
Determinant of Long-Run Economic Growth
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How to Increase productivity?
• An increase the capital stock, increases
capital per worker and increases productivity
• Capital per worker
– Total capital stock divided by total
employment
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Capital Accumulation and the Production
Function
An increase in the
Real Output
D
$12 trillion
$10 trillion
A
150
Millions
of Workers
capital stock shifts
the production
function upward.
At point A, 150
million workers
could produce $10
trillion of real GDP.
With more capital,
those same
workers could
produce $12 trillion
of real GDP.
Workers are more
productive.
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What Determines How Fast the Capital
Stock Rises?
• Planned investment spending (IP)
– recall this is a flow variable.
– the capital stock is a stock variable
• A higher rate of investment spending
causes:
– faster growth in capital per worker which
increases the growth in productivity
– faster growth in GDP - the standard of
living
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Capital Stock and Investment
• Suppose capital stock is $1000 billion at
the beginning of 2010
• Investment spending in 2010 is $100
billion
• Depreciation is $20 billion.
• What is the capital sock at the end of
2010?
• Capital stock = $1000 + $100 – $20
= $1080
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Big Question - How to Increase Investment?
• Government could do three things
– increase incentives for businesses to
invest
– increase incentives for households to save
– shrink the government budget deficit
• Think about the loanable funds model
presented in Chapter 8
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How to Increase Investment
1. increase incentive for business to invest
– Lower Corporate profits tax
• A tax on the profits earned by corporations
– Give Investment tax credit
• A reduction in taxes for firms that invest in new
capital
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An Increase in Investment Spending Increases the Demand for Loanable Funds
Interest
Rate
B
5%
3%
A
1.5
1.75
Government policies
Supply of
that make investment
Funds (Saving)
more profitable will
increase investment
spending at each
interest rate. The
resulting rightward
F
shift of the investment
New Demand demand curve (by the
for Funds (I2p) distance AF) leads to
a higher level of
Original
investment spending,
p
Demand for Funds (I1 )
at point B.
2.25
Trillions of Dollars
per Year
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How to Increase Investment
2. Increase incentive for households to save
• Decrease capital gains tax rate
- Capital gain is the increase in value of an
asset.
• Switch to a consumption tax
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How to Increase Investment
• Lower Capital Gains Tax
– Tax on profits earned when a financial
asset is sold at a gain
• Consumption tax
– rather than a tax on household income,
tax the part of income that households
spend. Result:
• more household saving
• more funds available for investment
• faster growth in the capital stock
• faster growth in living standards
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An Increase in Saving
Interest
Rate
Original Supply
of Funds (S1)
New Supply
of Funds (S2)
5%
F
A
B
3%
Demand for
Funds (Ip)
1.75
2.25 2.5
If households decide
to save more of their
incomes, the supply of
loanable funds curve
will shift rightward (by
the distance AF). With
more funds available,
the interest rate will
fall. Businesses will
respond by increasing
their borrowing, and
investment will
increase from $1.75
trillion to $2.25 trillion.
Trillions of Dollars
per Year
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How to Increase Investment
3. Decrease in the budget deficit
– this will reduce the demand for loanable
funds
– reduce interest rates,
– increase investment spending and the
growth in the capital stock
• But, the impact of deficit reduction on
economic growth depends on which
government programs are cut
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Deficit Reduction and Investment Spending
Interest
Rate
5%
Supply of
Funds
(Saving)
A
E
B
3%
[Ip + (G - T)]
Ip
1.0
1.5
1.75
Reducing the budget
deficit will reduce
government borrowing
in the loanable funds
market. The total
demand for funds will
fall, as will the interest
rate. At a lower interest
rate, businesses will
increase investment
spending from $1.0
trillion (point E) to $1.5
trillion (point B).
Trillions of Dollars
per Year
Crowding-in. The opposite of crowding-out
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Human Capital and Economic Growth
• An increase in human capital
– Works like an increase in physical capital
to increase output
– Causes production function to shift
upward
– Can raise productivity and living standards
• Increase of investment in human capital
– investment in education
– benefits take a long time to be realized.
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Limits to Growth From New Capital
– Diminishing returns
– Depreciation
– Thus, increases in the capital stock alone
cannot create permanent high rates of
economic growth
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Technological Change
• Technological change
– Invention and use of new inputs, new
outputs, or new production methods
– Extra boost to production from the new,
productivity-enhancing technology.
• The faster the rate of technological
change
– The greater the growth rate of productivity
– The faster the rise in living standards
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The Costs of Economic Growth
• Nothing is Free! Unavoidable tradeoffs –
• Promoting economic growth requires
some groups, or the nation as a whole, to
give up something else that is valued
• Properly targeted tax cuts (such as capital
gains or corporate profit)can increase the
rate of economic growth but force us to
either redistribute the tax burden or cut
government programs
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The Costs of Economic Growth
• Greater investment in physical capital,
human capital, and R&D
– faster economic growth and higher living
standards in the future
– but, fewer consumer goods to enjoy in the
present
• Increased saving today
- means less consumption today
- higher consumption in the future.
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Consumption, Investment, and Economic Growth
Production of
Consumption Goods
B
C
E
D
A
K Production of
Capital Goods
In the current period, a
nation can choose to
produce only consumer
goods (point C), or it can
produce some capital
goods by sacrificing
some current
consumption, as at point
A. If investment at point
A exceeds depreciation,
the capital stock will
grow, and the production
possibilities frontier will
shift outward. After it
does, the nation can
produce more
consumption goods
(point B), more capital
goods (point D), or more
of both (point E).
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