Macro Chapter 16

Creating an Environment for Growth and Prosperity

3 Learning Goals

1) Explain the relationship between output and income

2) Identify the general sources of economic growth

3) Identify specific institutional factors that promote economic growth

2 major issues in macroeconomics:

1. Growth

2. Short run fluctuations

History of Economic Growth

Steady economic growth is desirable because:

(1) Output growth means more goods and services per person

(2) Output growth leads to income growth

(3) People will make better decisions than if faced with highly variable changes

(4) More people will be employed

Here’s the possible impact of just slightly reducing our long-run growth rate:

If we grow at an average annual rate of 3%, national income will double about every 23 years.If we only grow at an average of 2.5%, national income will double about every 28 years.If we grow at an average of 3.5%, national income will double about every 20 years.

Here’s the possible impact of just slightly reducing our long-run growth rate:

Starting with 2011 GDP of $15.2 trillion, if we grow at an average annual rate of 3% GDP will grow by about $79 trillion in your lifetime.If we only grow at an average of 2.5%, GDP will grow by about $55 trillion; $24 trillion lessIf we only grow at an average of 2%, GDP will grow by about $36 trillion; $43 trillion less

Economic Growth, Production

Possibilities, and the Quality of Life

Watch video: Hans Rosling 200 Countries 200 Years

Sources of Economic Growth and High

Incomes

Q16.1 Which of the following is least likely to help the residents of a nation produce more goods and services and achieve higher income levels?

1. higher tax rates

2. a lower rate of investment

3. a smaller trade sector

4. greater use of taxation to transfer income from the rich to the poor

Watch video: Stossel Macro 09- economic freedom and prosperity

Q16.2 Which of the following is most likely to help the residents of a nation produce more goods and services and achieve higher income levels?

1. lower tax rates

2. a higher rate of investment

3. a larger trade sector

4. less use of taxation to transfer income from the rich to the poor

4 key sources of growth:1) Gains from trade

See gains from trade from Chapter 1- remember the trading game in class? Value is created through voluntary trade

See comparative advantage from Chapter 2- each country should make the good/service for which they have a low opportunity cost

2) Entrepreneurship and technology

Joseph Schumpeter’s “creative destruction”

3) Investment in physical and human capital

Physical capital = machines, equipment, and buildings

Human capital = knowledge and skills

A tradeoff exists between consumption and investment

Ceteris paribus, those countries who reduce consumption to increase investment grow faster

4) Institutions

Institutions = “rules of the game” or the policies and regulations that govern behavior

Institutions can be both the official laws and societal norms

Q16.3 When individuals and businesses are permitted to trade freely over a larger market area,

1. wages will decline to the level of the poorest country in the region.

2. the monopoly power of business firms will increase.

3. they will be able to produce a larger output and consume a more diverse bundle of goods.

4. businesses will be able to earn higher profits, but the income levels of individuals will decline.

Q16.4 Which of the following is a driving force underlying economic growth?

1. trade restrictions that protect domestic businesses from competition with foreign producers

2. regulations that require businesses to obtain permission from the government before starting a new business

3. tax increases that expand the revenues of the government

4. entrepreneurial discovery and production of improved products

What Institutions and Policies Will Promote

Growth?

See Thumbnail Sketch on p. 327

Key institutions:1) Secure property rights and political stability

2) Competitive markets

3) Stable money and prices

4) Minimal regulation

5) Relatively low marginal tax rates

6) Trade openness

Let’s see these in action

Watch video: Stossel Macro 10- institutions, growth, freedom

Watch video: Stossel MECA- why do nations prosper?

Q16.5 A legal system that protects private property and enforces contracts in an even-handed manner helps promote economic growth because it

1. makes it possible for individuals to generate large incomes and get ahead without cooperating with others.

2. provides people with a strong incentive to supply others with things that they value at an economical price.

3. encourages people to use resources now rather than conserving them for the future.

4. keeps the real wages of workers low and thereby makes it possible for business firms to supply goods and services economically.

Q16.6 When the residents of a nation are free to trade with foreigners, domestic producers will be able to

1. export more goods for which they are a high-cost supplier.

2. supply a larger quantity of goods they can produce at a relatively low cost.

3. charge higher prices then would otherwise be the case.

4. survive in the marketplace even if they do not produce efficiently.

Question Answers

16.1 = any (survey)

16.2 = any (survey)

16.3 = 3

16.4 = 4

16.5 = 2

16.6 = 2