Transcript chapter20 - YSU

Chapter 20
Economic Growth
and
Rising Living Standards
1
Economic Growth
• What determines the potential output?
– Labor productivity or Productivity
Amount of output average worker can produce in an hour
– Average hours of labor
Number of hours average worker spends at the job
– Labor force participation rate (LFPR)
Fraction of population that wants to work
– Size of population
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What Determines the Potential Output?
• Labor productivity
Total real output
Output per hour 
Total hours of labor
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What Determines the Potential Output?
• Average hours of labor
Average hours 
Total hours of labor
Labor force
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What Determines the Potential Output?
• Labor force participation rate (LFPR)
Labor force
LFPR 
Population
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What Determines the Potential Output?
• Breaking down the total output
Total output
Total hours of labor Labor force
Total output 


 Population
Total hours of labor
Labor force
Population
Total output  Labor productivi ty  Aeverage hours  LFPR  Population
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What Determines the Potential Output?
• Review of some linear algebra
If Z = X ∙ Y, then % Δ Z ≈ % ΔX + % ΔY
If Z = X ∙ Y, then % Δ Z ≈ % ΔX + % ΔY
• Applying this rule to the equation of total output
%Total output  %Productivi ty  %Average hours  %LFPR  %Population
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Economic Growth
• What matters for a rising standard of living is real
GDP per capita (i.e. per person)
Since
- Total output = Productivity x Average Hours x LFPR x Population
Then
- Output per capita = Total output ÷ Population
Output per capita = Productivity x Average Hours x LFPR
In terms of percentage growth rates
%Output per capita  %Productivi ty  %Average hours  %LFPR
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Economic Growth
• A tendency in most developed countries is that
average hours of labor are slowly decreasing
So our last simplification is to ignore changes in
average hours in the equation
% Δ Output per person ≈ % Δ productivity + % Δ LFPR
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Growth in the Labor Force
Participation Rate (LFPR)
Recall that
LFPR 
Labor Force
Population
So, %LFPR  %Labor force - %Population
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Growth in the Labor Force
Participation Rate (LFPR)
• Currently, U.S. Bureau of Labor Statistics predicts the
employment growth rate to be 1% per year until 2010,
about the same as the growth rate of population
– If so, the % Δ LFPR ≈ % Δ Labor force - % Δ Population = 0
– Is there anything we can do to make the labor force
grow faster than population, and thus increase the rate
of economic growth?
• Yes
 Increase labor supply
 Increase labor demand
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Figure 1: An Increase in Labor
Supply
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Figure 2: An Increase in Labor
Demand
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Figure 3: The U.S. Labor Market
Over A Century
Real
Hourly
Wage
S
S
L1
L2
B
W2
W1
A
D
L2
D
L1
L1
L2
Millions
of Workers
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How To Increase Employment
• Supply side
– Cut income tax
• Paying 40% of one’s income as taxes (federal, state, and local)
discourages work effort in the United States.
• Tax cut would provide incentives to people to seek jobs
• Labor supply curve shifts rightward
– Changes in government transfer programs
• Reduce social benefits
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How To Increase Employment
• Demand side
– Government policies that help increase skills of the
workforce or that subsidize employment
• government-sponsored training programs
• aid to college students
• employment subsidies to firms
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Growth in Productivity
• Recently, virtually all growth in the average
standard of living can be attributed to growth in
productivity
• What can we do to make productivity grow?
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Figure 4: Capital Accumulation and
Labor Productivity
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Growth in the Capital Stock
• One key to productivity growth is growth in nation’s capital
stock
– With more capital, a given number of workers can
produce more output than before
• Growth in capital stock will increase productivity as long as
it increases amount of capital per worker
Since capital per worker 
Total capital stock
,
Labor force
% capital per worker  % Total capital stock - % Labor force
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Investment and the Capital Stock
• A stock variable measures a quantity at a moment in time
– Capital stock is a measure of total plant and equipment
in economy at any moment
• A flow variable measures a process that takes places over
a period of time
– Planned investment is a flow variable
• Depreciation is decrease in the value of assets
– As long as investment is greater than depreciation, total
stock of capital will rise
– The greater the flow of investment, the faster will be the
rise in capital stock
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Targeting Businesses – Demand Side
Reducing business taxes
• Corporate profits tax
– A cut in tax on profits earned by corporations
• Investment tax credit
– A cut in taxes for firms that invest in certain favored types of capital
• Reducing business taxes or providing specific investment
incentives can shift the investment curve (the demand
curve in the loanable funds market) rightward
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Figure 5: An Increase In Investment
Spending
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Targeting Households – Supply Side
• If households decide to save more of their incomes at any given
interest rate
– Supply of loanable funds curve will shift rightward
• What might induce households to increase their saving?
–
–
–
–
–
Greater uncertainty about economic future
Increase in life expectancy
Anticipation of an earlier retirement
Change in tastes toward big-ticket items
Change in attitude about saving
• Any of these changes—if they occurred in many households simultaneously—
would shift saving curve to the right
• What can government do to increase household saving?
– One often-proposed idea is to decrease capital gains tax
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Figure 6: An Increase In Savings
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Government’s Budget Deficit
• A increase in government purchases tends to raise interest
rates
• High interest rates discourage business investments
So, to induce businesses to invest more, government should
reduce its purchases
–Shrinking deficit or rising surplus tends to reduce interest rates and
increase investment
–However, the effect on economic growth depends on how the budget
changes
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Figure 7: Deficit Reduction and
Investment Spending
Interest
Rate
5%
Supply
of Funds
(Saving)
E
A
B
3%
Investment
Investment
Spending Spending + Deficit
1.0
1.5 1.75
Funds
($ Trillions)
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Human Capital and Economic Growth
• Human capital
– Skills and knowledge possessed by workers
• An increase in human capital works like an increase in
physical capital to increase output
– Causes production function to shift upward
• Raises productivity and increases average standard of living
• Human capital investments
– Education
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Technology and Economic Growth
• Another source of growth is technological change
– Invention or discovery of new inputs, new outputs, or new methods
of production
• New technology affects economy in much the same way
as do increases in capital stock
– Shifts production function upward
• Since it enables any given number of workers to produce more
output
• Investments in technology
– R&D
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