Transcript Eco120Int_Lecture11

ECO 120
Macroeconomics
Week 11
Economic Growth
Lecturer
Dr. Rod Duncan
Topics
• Long run in the AD-AS model
• Growth or macroeconomics of the long-run
Long-run in the AD-AS model
• So far, all the macroeconomics we have
done is short-run.
• In terms of a story, we have:
– A beginning where the economy starts off in
long-run equilibrium at the natural rate of
output and some price level; and
– A middle where some shock occurs and the
economy is affected, so Y shifts up or down
and P shifts up or down.
Beginning and middle
AS1
P
Y*
AS0
P1
P0
AD
Y1
Y0
Y
• A rise in oil prices
raises the cost of
production for all
producers and shifts
the SR AS curve up/to
the left.
• At the old prices, AD
> AS, so prices rise
and output falls.
A story with no end?
• And then what?
• And then nothing, so far. Our story does not
have an end yet.
• A good story, such as DreamWork’s “Shrek”has:
– Beginning- Shrek in his swamp;
– Middle- Shrek goes on a journey and rescues a
princess;
– End- Shrek returns to his swamp- a better ogre and
with his princess.
A story with no end?
A Story
• So all good stories
have a circular
pattern. At the end,
we comes back to the
beginning.
• Even in an economics
story, we have to
have this sort of
pattern.
End
Beginning
Middle
An end = Natural rate
• For the “natural rate of output” to make any
sense, in the long-run the economy must return
to this natural rate.
• Some design of the economy must push the
economy back to the natural rate- all booms and
all recessions eventually end.
• So what process pushes us back to the long-run
equilibrium- wage demands!
• All booms and all recessions come to an end
because companies and workers change
wages.
So where are we?
• The oil price shock
caused the As curve
to shift. We have
inflation, and a
recession- cost-pull
inflation.
• Unemployment is
high and output is
low.
• Firms are not hiring.
AS1
P
Middle Y*
AS0
P1
P0
Beginning
AD
Y1
Y0
Y
Adjustment after a recession
• Unemployment is high, but the firms are
not hiring workers because the firms’
energy and transportation bills are high.
• We have a surplus of labour at the current
price of labour- what effect do surpluses
have in markets?
– The price of labour gets bid down. Workers
offer lower wages simply to get jobs.
– The same as a surplus of oranges will lead to
a fall in price of oranges.
Adjustment after a recession
• As wages drop, the cost of production to firms
drops. So we would expect that the AS curve
will shift down/out to the right.
• [Remember: A shift down in the supply curve
means that firms are willing to supply more at
the same price or supply the same amount at a
lower price.]
• As the AS curve shifts down, output rises, prices
fall and unemployment drops, until we are back
at the natural rate of output again.
Adjustment after a recession
• A high level of
unemployment means
that workers are willing to
accept lower wages.
• A fall in W pushes the AS
down/right, so that Y rises
and unemployment falls.
• Fall in W continues until
We get back to Y*.
AS1
P
Middle Y*
AS2
P1
P2
AD
Y1
Y0
Y
Alternative solution- fiscal
• So the adjustment process for an oil price boom
and recession is for wages to fall.
• But this requires a period of high unemployment
and falling wages. Is there another alternative?
• What if the government responded to the
recession by stimulating AD through fiscal
policy?
• An increase in G would shift the AD curve to the
right, which would raise Y at the cost of higher P.
Alternative solution- fiscal
• During the recession,
we have low output
(Y1) and high
unemployment.
• Fiscal policy
stimulates AD0 to AD1.
• Output rises, and
unemployment falls.
But inflation rises, as
P rises to P2.
P
Middle Y*
AS1
P2
P1
P0
AD0
Y1
Y0
AD2
Y
Adjustment after a boom
• Our first adjustment
scenario was a
recession. Imagine
instead that we start
with a boom- an
increase in I due to
improved business
expectations.
• Investment rises, and
so the AD curve shifts
to the right.
P
Y*
AS0
P1
Middle
P0
Beginning
AD0
Y0
Y1
AD1
Y
Adjustment after a boom
• Y increases to Y1, so we have a boom with high
output and low unemployment.
• We have inflation, as P rises to P1.
• A low level of unemployment and a high level of
output means that there is excess demand for
labour (you will hear “skills shortage”).
• Excess demand for any good will lead to a rise
in prices, so the wage rate is pushed up as firms
offer workers more to stay or be hired.
Adjustment after a boom
• An increase in wages
will push the AS curve
up/in, as firms’
production costs rise.
• As the AS curve shifts
up, output falls, prices
rise and we move
back to Y*.
P
AS1
Y*
AS0
P2
P1
Middle
AD0
Y0
Y1
AD1
Y
Adjustment after a boom
• So the adjustment process after a boom is
for wages to rise, which will push the AS
curve up.
• So a boom will lead to a wage rise, which
will push inflation even higher.
• Is there a way to adjust to a boom that
does not require further inflation?
Alternative solution – monetary
• If the RBA responds to
the future increase in
wages by raising interest
rates now, we can avoid
the wage inflation
following a boom.
• A rise in i leads to a drop
in I, which shifts the AD
curve left.
• Output and prices fall
today.
P
Y*
AS0
P1
Middle
P2
AD2
Y0
Y1
AD1
Y
Long-run equilibrium
• Adjustment to a bust
– AS shifts up to AS1.
– Output falls, and prices rise
in the short-run.
– Wage demands shift AS
down to AS2.
– Output rises and prices fall
as we adjust to long-run.
– In long-run, output back to
natural rate, and prices
return to initial levels.
AS1
P
Y*
AS0=AS2
P1
P0
AD
Y1
Y0
Y
Long-run equilibrium
• Adjustment to a boom
– AD shifts out to AD1.
– Output and prices rise
in the short-run.
– Wage demands shift
AS left to AS2.
– Output falls and prices
rise as we adjust to
long-run.
– In long-run, output
back to natural rate,
and prices higher.
P
Y*
End
AS2
AS0
P2
P1
Middle
P0
Beginning
AD0
Y0
Y1
AD1
Y
Long-run growth
• We are ultimately interested in the level of
resources each individual in society has access
to. The level of resources will then somewhat
determine what opportunities each person has.
• So we are ultimately interested in GDP per
person of an economy. Growth is the increase
of GDP per capita over time.
• Y / N = output per person
Long-run growth
• But not every person in an economy is “economically
productive”, so if we want to link “worker productivity”
and GDP per capita , we need:
• Y / N = (Y/Nw) (Nw/N)
• Y/Nw = output per worker depends on labour productivity,
which depends on skills in workforce, capital, tech
• Nw/N = labour force participation rate which depends on
cultural attitudes and aging of the population
Labour force participation
• Growth in GDP per capita can come from
increasing Nw/N.
– As people move from subsistence farming on
rural areas to paid employment in urban
areas, labour force participation rises.
– As women move out of unpaid domestic work
to paid domestic work, labour force
participation rises.
• But obviously there is a limit to this sort of
growth.
Labour force participation
Australian Labour Force Part'n
0.6
0.5
0.4
0.3
0.2
0.1
19
50
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53
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56
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59
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62
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65
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68
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71
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77
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98
0
Labour force participation
• And as the Australian population ages, we
will eventually see this LFP start to
decline, as the population of retirees
increases.
• This will be a major challenge for Australia
in the relatively near future.
Output per worker
• Output per worker, Y/Nw, is the main source of
growth in Australia.
• So growth in Australia depends on increasing
the productivity of our workers. What
determines how productive a worker is?
– The skills of the worker.
– The physical capital the worker uses.
– The level of technology the worker and capital have
access to.
Output per worker
Australian Real GDP per Worker
60000
50000
40000
30000
20000
10000
19
50
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53
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56
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59
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62
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65
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68
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71
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77
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19
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0
Output per worker
• Output per worker was $22,000 in 1950
and $52,000 in 2000 in constant dollars.
(Once we remove the effects of inflation.)
• So how are Australian workers today over
twice as productive as workers in 1950?
– New technologies (mechanization, robotics,
computers, etc)
– More capital (powered floor polishers instead
of mops)
Output per capita
• So once we combine labour force changes
and worker productivity changes, we wind
up with change in output per capita over
time.
• Real GDP per capita was $9,200 in 1950
and $25,500 in 2000.
• Australians in 2000 have almost twice as
much resources per person than
Australians did in 1950.
Long-run growth in Australia
Australian Real GDP per Capita
30000
25000
20000
15000
10000
5000
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53
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0
Long-run growth in Australia
• While there was a temporary blip in GDP
in early 1950s, 1980s and 1990s, the
overall picture is one of steadily increasing
GDP per person over time.
• What can be done to ensure growth in
Australia?
– Increasing productivity per worker.
• Increasing skill levels, increasing capital
and increasing technology.
But remember…
• Remember what it is that GDP measures:
the market value of all goods and services
sold in the economy.
– Ignores non-market goods, such as domestic
work and pollution.
– Does not include black market goods.
– Having longer holidays might make for a
happier workforce, but would lower GDP.
Growth and economic development
What about other countries?
• Relative to the rest of the developed world,
Australia is a fast-growing economy.
• Australia is behind the United States, but
ahead of countries such as the UK and
NZ.
• Relative to our neighbours (East Asia),
Australia is a very prosperous country.
Relative to developed countries
Relative Real GDP per Capita
35000
30000
25000
20000
15000
Australia
USA
UK
NZ
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5000
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Relative to our neighbours
Relative Real GDP per Capita
30000
25000
20000
Australia
15000
10000
5000
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50
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53
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68
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0
Japan
Hong Kong
Indonesia
Convergence
• “Convergence” is the idea that we would
expect countries that are initially poorer
should grow faster than countries that are
richer.
• Why?
– Technology- Poor countries can piggy-back
for free off the technology developed by rich
countries.
– Capital flow- We expect investors to rush to
invest in countries with cheap wages.
Convergence
• Over time, we expect poor countries to
grow faster than rich countries, so GDP
per capita across different countries
should “converge” over time.
• Is this idea true?
• We saw that certain countries like Japan
and South Korea started off poorer than
Australia but caught up.
Catching up?
East Asian Miracle?
35000
30000
25000
20000
15000
Australia
Japan
USA
S Korea
China
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5000
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Malaysia
But look!
African development?
35000
30000
25000
20000
15000
Australia
USA
Kenya
Nigeria
Uganda
10000
5000
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Malawi
Log graph
Log scale graph of African problems
100000
10000
Australia
USA
1000
Kenya
Nigeria
100
Uganda
Malawi
10
20
00
19
90
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80
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70
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60
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1
Consequences of growth
Life
Adult
Enrollm
ent
Expectancy
Literacy
in Edu
per capita
HDI
Rank
Norway
78.5
100
97
29,918
0.942
1
Australia
78.9
100
116
25,693
0.939
5
USA
77
100
95
34,142
0.939
6
Japan
81
100
82
26,755
0.933
9
Indonesia
66.2
86.9
65
3,043
0.684
110
Kenya
50.8
82.4
51
1,022
0.513
134
Uganda
44
67.1
45
1,208
0.444
150
Malawi
40
60.1
73
615
0.4
163
GDP