Transcript Document

A Lecture Presentation
to accompany
Exploring Economics
3 Edition
by Robert L. Sexton
rd
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Printed in the United States of America
ISBN 0-324-26086-5
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Chapter 19
Economic Growth in the
Global Economy
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19.1 Economic Growth
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John Maynard Keynes
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primarily concerned with explaining and
reducing short-term fluctuations in the level
of business activity
once said, “in the long run we are all dead.”
He wanted to smooth out the business
cycle, largely because of the implications
that cyclical fluctuations had for buyers
and sellers in terms of unemployment
and price instability.
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Short Run Versus Long Run
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Keynes’ concerns were important
and legitimate.
At the same time, his flippant remark
about the long run ignores the fact
that human welfare is greatly
influenced by long-term changes in
a nation's capacity to produce goods
and services.
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Emphasis on the short-run business
cycle ignores the longer term dynamic
changes that affect output, leisure,
real incomes and life styles.
Many would argue that in the long
run, economic growth is a crucial
determinant of well-being.
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What are the determinants of long-run
economic change in our ability to produce
goods and services?
What are some of the consequences of
rapid economic change?
Why are some nations rich while others are
poor?
Does growth in output improve our
economic welfare?
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Defining Economic Growth
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Economic growth is usually
measured by the annual percent
change in real output of goods and
services per capita (real GDP per
capita).
Along the production possibilities
curve, the economy is producing at its
potential output.
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How much the economy will produce
at its potential output, sometimes
called its natural level of output,
depends on the quantity and quality
of an economy’s resources, including
labor, capital, and natural resources.
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13.1 Economic Growth
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Technology can increase the economy’s
production capabilities.
Improvements in and greater stocks of
land, labor, and capital can shift out
the production possibilities curve.
Another way of saying that economic
growth has shifted the production
possibilities curve out is to say that
growth has increased potential output.
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Copyright © 2002 by Thomson Learning, Inc.
The Rule of 70
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A nation with greater economic growth will
end up with a much higher standard of
living, ceteris paribus.
The Rule of 70 can tell how long it will
take a nation to double its output.
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The number of years necessary is
approximately equal to the nation’s growth rate
divided into 70. For example, if a nation grows
at 3.5% per year, then the economy will double
every 20 years (70/3.5)
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The “richest” or “most-developed”
countries today have many times the
per capita output of the “poorest” or
“least-developed” countries.
The international differences in
income, output, and wealth are
striking and have caused a great deal
of friction between developed and
less-developed countries.
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Standard of living is closely correlated with
productivity growth
Productivity is the amount of good and
services a worker can produce per hour
Slow growth of capital investment can lead to
lower labor productivity and consequently
lower wages
While increases in productivity, and
consequently higher wages, can occur as a
result of carefully crafted economic policies—
tax policies that stimulate investment or
programs that encourage R&D.
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The link between productivity and the
standard of living can be easily understood
by recalling our circular flow model.
In the circular flow model aggregate values
of all goods and services produced in the
economy must equal the payments made
to the factors of production.
So the only way an economy can increase
its rate of consumption in the long run is if
they increase the amount they produce.
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Copyright © 2002 by Thomson Learning, Inc.
19.2 Determinants of
Economic Growth
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Many separate explanations of economic
growth have been proposed, but none of
them, by themselves, can completely
explain economic growth.
However, each of the explanations may
be part of a more complicated reality.
Economic growth is a complex process
involving many important factors, no
one of which completely dominates.
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Nearly everyone agrees that several
factors have contributed to economic
growth in some or all countries.
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growth in the quantity and quality of
labor resources used
increase in the use of inputs provided
by land
growth in physical capital inputs
technological advances allowing greater
output than previously possible
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Labor is needed in all forms of
productive activity.
Other things being equal, an increase
in labor input does not necessarily
increase output per capita.
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If the increase in labor input results
from an increase in population, per
capita growth might not occur
because the increase in output could
be offset by the increase in
population.
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If a greater proportion of the
population works or if workers put
in longer hours, output per capita
will increase—assuming that the
additional work activity adds
something to output.
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Qualitative improvements in workers
(learning new skills, for example) can
also enhance output.
It has become popular to view labor
as "human capital" that can be
augmented or improved by education
and on-the-job training.
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Abundant natural resources also can
enhance output whereas a limited
resource base is an important
obstacle to economic growth.
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Resources are not the whole story.
The natural resource base can affect
the initial development process, but
sustained growth is influenced by
other factors.
There is nearly universal agreement
that capital formation has played a
significant role in the economic
development of nations.
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Technological advances stem from
man's ingenuity and creativity in
developing new ways of combining
the factors of production to enhance
the amount of output from a given
quantity of resources.
It involves invention and innovation.
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Innovation is the adoption of a new
product or process.
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New technology must be introduced
into productive use by managers or
entrepreneurs who must weigh their
estimates of benefits of the new
technology against their estimates
of costs.
The entrepreneur is an important
economic factor in the growth
process.
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Technological advances permit us to
economize on one or more inputs
used in the production process.
It can permit savings of labor, as
occurs when a new machine is
invented that does the work of
many workers.
It can also be land (natural resource)
saving or even capital saving.
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Nuclear fission has permitted us to
build power plants that economize on
the use of coal, a natural resource.
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The reduction in transportation time
that accompanied the invention of the
railroad allowed businesses to reduce
the capital they needed in the form of
inventories.
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Because goods could be obtained quickly,
businesses could reduce the stock kept
on their shelves.
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19.3 Raising the Level of
Economic Growth
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Economic growth means more than
an increase in the real income
(output) of the population.
Changes in output are accompanied
by a number of other important
changes.
There are a number of policies that
a nation can pursue to increase
economic growth.
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Saving Rates, Investment, Capital
Stock, And Economic Growth
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One of the most important
determinants of economic growth
is the saving rate.
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In order to consume more in the future,
we must save more now.
Generally speaking, higher levels of
saving will lead to higher levels of
investment and capital formation and,
therefore, to greater economic growth.
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Sustained rapid economic growth is
associated with high rates of saving
and investment around the world.
Investment alone does not guarantee
economic growth, which hinges
importantly on the quality and the
type of investment as well as on
investment in human capital and
improvements in technology.
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Research And Development
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Some scholars believe that the
importance of research and
development (R&D) is understated.
It can include
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new products
management improvements
production innovations
simply learning by doing
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It is clear that investments in R&D
and rewarding innovators with
patents has paid big dividends in
the past 50 to 60 years.
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There is an important link between
research and development and capital
investment.
When capital depreciates over time, it
is replaced with new equipment that
embodies the latest technology.
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Consequently, R&D may work hand-inhand with investment to improve growth
and productivity.
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The Protection Of Property Rights
Impacts Economic Growth
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Economic growth rates tend to be
higher in countries where the
government enforces property rights.
In most developed countries,
property rights are effectively
protected by the government, but
in developing countries, this is not
normally the case.
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And if the government is not
enforcing property rights, the private
sector must respond in costly ways
that stifle economic growth.
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private security
bribes
corruption
confiscation
the risk of takeovers from a new
government
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Free Trade And Economic
Growth
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Free trade can lead to greater output
because of the principle of comparative
advantage.
 If two nations or individuals with different
resource endowments and production
capabilities specialize in producing a
smaller number of goods and services,
then they are relatively better at and
engage in trade.
 Both parties will benefit as total output
rises.
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Education
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Education, investment in human
capital, is just as important as
improvements in physical capital.
Accepting a reduction in current
income to acquire education and
training can increase future earning
ability, which can raise the standard
of living.
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With economic growth, illiteracy rates fall
and formal education grows.
The correlation between per capita output
and the proportion of the population that
is unable to read or write is striking.
Improvements in literacy stimulate
economic growth by reducing barriers to
the flow of information and raise labor
productivity.
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Since children in developing countries
are an important part of the labor force
at a young age, there is a higher
opportunity cost of education in terms of
forgone contribution to family income.
Education is a consequence of economic
growth, becoming a consumption good,
as well as a cause of economic growth,
creating human capital.
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19.4 Population and
Economic Growth
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At the beginning of the English
Industrial Revolution (around 1750),
the world’s population was
approximately 700 million.
It took 150 years (to 1900) for that
population to slightly more than
double to 1.6 billion.
Just 64 years later (in 1964), it had
doubled again to 3.2 billion.
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Population Growth And
Economic Growth
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After another 40 years (in 2004), it
is likely that the population will have
doubled yet again to more than 6.4
billion (the world population was 6.2
billion in 2001).
We have had economic development
amidst all this growth in population,
but what role does population play in
economic growth?
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If population were to expand faster than
output, per capita output would fall;
population growth would inhibit growth.
With a larger population, however,
comes a larger labor force.
Certainly, very rapid population
growth—more than 3 percent a year—
did not seem to impede U.S. economic
growth in the mid-19th century.
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U.S. economic growth until at least
World War I was accompanied by
population growth that was among
the highest in the world for the time.
There is a general feeling that in
many of the developing countries
today, rapid population growth
threatens the possibility of attaining
sustained economic growth.
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These countries are predominantly
agricultural with very modest natural
resources, especially land. The landlabor ratio is very low.
Why is population growth a threat in
these countries?
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The Malthusian Prediction
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Malthus formulated a theoretical
model that predicted that per capita
economic growth would eventually
become negative and that wages
would ultimately reach equilibrium
at a subsistence level, or just large
enough to provide enough income
to stay alive.
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Malthus made three assumptions:
1.
2.
3.
The economy was agricultural,
with goods produced by two
inputs, land and labor
The supply of land was fixed
Human sexual desires worked to
increase population
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The Law Of Diminishing
Marginal Returns

As population increases, the number
of workers increases, and with
greater labor inputs available, output
also goes up.
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
A some point, however, output will
increase by diminishing amounts
because of the law of diminishing
returns, which states that you add
variable amounts of one input (in this
case, labor) to fixed quantities of
another input (in this case, land), output
will rise but by diminishing amounts
(because as the land-labor ration falls,
there is less land per worker).
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Avoiding Malthus’s Prediction
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Malthus’s theory proved wrong for much
of the world.
The quantity or quality of cultivable land
is not completely fixed.
Malthus implicitly assumed there would
be no technological advances and ignored
the real possibility that improved
technology could overcome the impact of
the law of diminishing returns.
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
The Malthusian assumption that
sexual desire would necessarily lead
to population increase is not accurate
because the number of births can be
reduced by birth control techniques.
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
In some countries, a larger population
may lead to more entrepreneurs,
engineers, and scientists who will
contribute to even greater economic
growth through technological
progress.
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Do Some Developing Countries Still
Fit Malthus’s Prediction Today?
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Some developing nations of the world
are having substantial population
increases, with a virtually fixed supply
of land, slow capital growth, and few
technological advances.
In fact, some have tried to reduce the
rate of population growth to achieve
greater economic growth per capita
and higher standards of living.
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While high population growth rates
may be one explanation for lower
standards of living, there are many
non-Malthusian explanations for the
recurring poverty that exists in
developing countries today:
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Political instability
Lack of defined and enforceable property
rights
Inadequate investment in human capital
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