Transcript Economic_growth - YSU

Economic Growth
Long-Run Economic Growth
and
Rising Living Standards
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Economic Growth
• Long-run economic growth
– Increase in real GDP per capita over time
– Increase in the standard of living
– Growth rates and the rule of 70
• Business cycle
– Fluctuations about the long-run growth trend
– Recessions alternate with expansions.
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Long-Run Economic Growth
• What determines the potential output?
– Labor productivity or Productivity
Amount of output one average worker can produce in an
hour
– Average hours of labor
Number of hours one 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?
• 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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Long-Run Economic Growth
• What matters for a rising standard of living is real
GDP per capita (i.e. per person)
Since
- Total real output = Productivity x Average Hours x LFPR x Population
Then
- Real output per capita = Total output ÷ Population
Real 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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Long-Run 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 LFPR
Recall that
LFPR 
Labor Force
Population
So, %LFPR  %Labor force - %Population
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Growth in 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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Labor Market
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An Increase in Labor Supply
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An Increase in Labor Demand
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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
• The sources for the growth in productivity
–
–
–
–
Capital stock
Human capital
Technological development
Entrepreneurship
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Figure 4: Capital Accumulation and
Labor Productivity
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Growth in the Capital per Worker
• 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
Total capital stock
Since capital per worker 
,
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 place over a period of
time.
– 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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Saving and Investment
• Private saving
S private  Y  C  (T  TR)
• Public saving
S public  (T  TR)  G
• Total saving = Private saving + Public saving
S  S private  S public  Y  C  G  I  NX
• In a closed economy,
SI
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The Loanable Funds Market
• Where households make their saving available to those
who need additional funds
• Supply of loanable funds – household saving
• Demand of loanable funds – businesses and government
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The Loanable Funds Market
• Businesses’ demand for loanable funds is equal to their
planned investment spending (Ip)
– Funds obtained are borrowed, and firms pay interest on their loans
• Government’s demand for loanable funds
– Budget deficit (G – T)
Excess of government purchases over net taxes
• Government’s supply for loanable funds
– Budget surplus (T – G)
Excess of net taxes over government purchases
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Supply of Household Loanable Funds
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Business Demand for Loanable Funds
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The Demand for Funds
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Loanable Funds Market Equilibrium
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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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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.
•Crowding out effect
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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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
• Technological development is the key to sustaining
economic growth
– The law of diminishing returns to capital
– Solow economic model
• Endogenous growth theory
– Technological change is not random but determined by factors in
the market system.
– The principle that marginal cost equals marginal revenue in profit
maximization applies in the determination of the amount of
knowledge investment firms would like to make.
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Technology and Economic Growth
• New technology affects economy in the way that it enables
any given number of workers to produce more output.
– Production function shifts upward.
• Government policies that encourage investment in
technology
– Protecting intellectual property rights
– Subsidizing research and development
– Subsidizing education
• Entrepreneurship
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