Ch07 all macro__lecture_ppt

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Chapter 7Economic Growth


Chapter Outline

7.1 The Power of Economic Growth

7.2 How Does a Nation's Economy Grow?

EBE Why are you so much more prosperous than your great-great-grandparents were?

7.3 The History of Growth and Technology

7.4 Growth, Inequality, and Poverty

7 Economic Growth


Key Ideas

1. Economic growth measures how much (real) GDP per capita grows over time.

2. Today’s high levels of GDP per capita in many nations are a result of rapid economic growth over the last two centuries.

3. Sustained economic growth relies on technological progress.

7 Economic Growth


Key Ideas

4. There are sizable differences in the historical growth rates of different economies, which are largely responsible for their differences in the levels of GDP per capita.

5. Economic growth is a powerful tool for poverty reduction.

7 Economic Growth



Economic growth, or growthThe increase in GDP per capita of an economy.

In 1820, the level of GDP per capita was $1,858.





Exhibit 7.1 GDP per Capita in the United States (2005 constant dollars)


Growth rate The change in a quantity between two dates, relative to the beginning date (baseline).

Let us choose two dates, t and t+1, and denote GDP per capita in those dates as y and


1, 1

t tt t

t

y ygrowth

y


U.S. Annual Growth Rate of GDP per Capita

2005,2006

$43,215 $42,482 Growth = = 0.017

$42,482

2012,2013

$45,835 $45,336 Growth = = 0.011

$45,336



The annual growth rate of GDP per capita of the U.S. economy is mostly positive but can be negative, as it was in 2007–2008 and 2008–2009.

The average annual growth rate of the U.S. economy between 1950 and 2012 is 2.03%.




Exhibit 7.2 The Annual Growth Rate of GDP per Capita in the UnitedStates Between 1950 and 2012 (2005 constant dollars)


Exponential growth A process by which a quantity, like GDP per capita, grows at a constant proportion or growth rate.



Suppose Y in 2010 is growing at 10% each year.

What would be the value of Y in 2015?

You earn 10% each year, so the total increase would be 0.10 × 15 = 1.50 in 15 years:

Y2015 = Y2000 × 1.50 … WRONG



With exponential growth, new growth builds on past growth, and its effects compound:

Y2001 = Y2000 × 1.10

Y2002 = Y2001 × 1.10 = Y2000 × 1.10 × 1.10 = Y2000 × 1.102

Y2003 = Y2002 × 1.10 = Y2000 × 1.102 × 1.10 = Y2000 × 1.103

Y2004 = Y2003 × 1.10 = Y2000 × 1.103 × 1.10 = Y2000 × 1.104



With exponential growth, new growth builds on past growth, and its effects compound:

Y2005 = Y2000 × 1.105 = Y2000 × 1.61 > Y2000 × 0.50

Y2010 = Y2000 × 1.1010 = Y2000 × 2.69 > Y2000 × 1.00

Y2015 = Y2000 × 1.1015 = Y2000 × 4.18 > Y2000 × 1.50



One implication of exponential growth is that it is much more convenient to use an axis with a proportional scale.

A 10% growth rate starting from 1,000 will take us to 1,100, for a change of 100.

A 10% growth rate starting from 10,000 will take us to 110,000, for a change of 10,000.



1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 200

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Two Variables Growing at 10% in a Constant Scale

Time



1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 201,000

10,000

100,000

Two Variables Growing at 10% in a Proportional Scale

Time



An important implication of exponential growth is that small changes in growth rates lead to large differences in the level of GDP per capita.



Consider three countries with the same starting level of GDP per capita, Y1810.

What would be GDP per capita in 2010 (200 years) if each country grew at 0%, 1% , and 2%?

Y2010 = $1,000 if annual growth is 0%





Let’s look at what exponential growth implies about the growth experiences of rich vs. poor countries and fast vs. slow growers.

We use a 1960 to 2010 data set where GDP per capita is in PPP-adjusted 2005 constant dollars.



Richest and Poorest Economies

Real GDP per Capita Growth (%)

1960 2010

Luxembourg 17,601 75,589 2.91

Singapore 4,383 55,862 5.22

Norway 12,524 50,488 2.79

United States 15,398 41,365 2.00

Austria 15,256 41,114 1.98

Central African Rep. 968 589 –0.99

Niger 861 522 –1.00

Burundi 344 397 0.29

Zimbabwe 285 320 0.23

Dem. Rep. of Congo 696 241 –2.10



Fastest- and Slowest-Growing Economies

Real GDP per capita Growth (%)

1960 2010Singapore 4,383 55,862 5.22Botswana 674 9,676 5.33South Korea 1,656 26,609 5.71Taiwan 1,862 32,105 5.69Equatorial Guinea 611 13,959 6.26Guinea 915 788 ‒0.30Madagascar 1,052 703 ‒0.81Central African Rep. 968 589 ‒0.99Niger 861 522 ‒10Dem. Rep. of Congo 696 241 ‒2.10



What about the implied average growth rates for all countries?

The next slide shows that the majority of nations have experienced average annual growth in real GDP per capita of 1%‒3%.



Exhibit 7.7 Average Growth Rates of GDP per Capita from 1960 to 2010(PPP-adjusted 2005 constant dollars)



What about the implied average growth rates for longer time periods?

The Maddison Project, named after the late Angus Maddison, has estimated growth rates for numerous countries back to 1820 and beyond.

We look at the implied growth rates for a few of these countries in the next slide.



1820 1870

1920

1970 2010 (1820– 2010)

(1920– 2010)

U.K. 2,854 4,391

6,259

14,818

32,722

1.29 1.85

U.S. 1,873 3,364

7,641

20,684

41,962

1.65 1.91

Argentina 1,374 2,020

4,780

10,049

14,115

1.23 1.20

Hong Kong 846 940 1,760

7,838 42,283

1.92 3.56

Chile 832 1,776

3,810

7,199 19,106

1.65 1.80

South Korea 461 464 839 2,983 29,864

2.22 4.05



There are two important take-aways from these growth tables.



1. Catch-up growth: Poor countries tend to grow faster, or “catch up,” to rich countries as they adopt the production and technologies of the richest countries.

Examples include Chile, Hong Kong, and South Korea.

As Argentina shows, however, catch-up growth is not guaranteed.



2. Sustained growth: Some countries experience positive and relatively steady growth rates over 50- , 100-, and even 200-year periods.

Examples include the United Kingdom, United States, France, and Spain.



How does a nation’s economy grow?

Let us return to the aggregate production function of Chapter 6:

( )Y = A × F K,H

7.2 How Does a Nation’s Economy Grow?


A nation can increase its GDP by:

1. Increasing its stock of physical capital, K

2. Increasing the total efficiency units of labor, H

3. Improving its technology, A



7.2 How Does a Nation’s Economy Grow?Capital Accumulation

Consider a simply economy where there is no government nor exports nor imports, so that G = X = M = 0.

Therefore, on the expenditure side, Y = C + I.

Similarly, on the income side, Y = C + S.

Setting the two equations together, I = S.


What determines aggregate saving, S?

Individual households decide how much of theirincome they consume andhow much they save.

Consumption brings immediate happiness, while saving leads to future consumption and thus future happiness.

7.2 How Does a Nation’s Economy Grow?Optimization: The Choice Between Saving and Consumption


The individual consumption-saving decision is ultimately an optimization problem where the relevant price is the interest rate.

The sum total of these individual decisions determine the saving rate of the economy:

7.2 How Does a Nation’s Economy Grow?Optimization: The Choice Between Saving and Consumption


Physical capital accumulation by itself cannot generate sustained growth due to the diminishing marginal product of physical capital.

Why? More and more capital will generate smaller and smaller increases in GDP.

Therefore, a constant or sustained growth rate cannot be achieved.



Similarly, population growth and education by themselves cannot generate sustained growth due to the diminishing marginal product of labor and diminishing marginal product of skills.

Why? More and more labor will generate smaller and smaller increases in GDP.

Therefore, a constant or sustained growth rate cannot be achieved.



Technological change The process in which new technologies and new goods and services are invented, introduced, and used in the economy. Such change can generate sustained growth.



Exhibit 7.9 The Real Price of Light over Time



Technological change is more than a constant increase, such as 10 more units. Rather, it is exponential in that the rate of increase is approximately constant, such as 10%.

Why? New innovations and technologies build on the existing stock of knowledge—“building on the shoulders of giants”—and thus are not subject to diminishing returns.



Evidence-Based Economics Example

Question: Why are you so much more prosperous than your great-great-grandparents were?

Data: The following table presents estimates of GDP per hour worked, physical capital stock per hour worked, and average years of schooling for 10-year periods starting in 1950.

7 Economic Growth


Exhibit 7.10 (Columns 1-3) Contribution of Technology, Physical Capital, and Human Capital to the Growth of GDP per Hour Worked in the United States Between 1950 and 2007.

7 Economic Growth


7 Economic Growth

Exhibit 7.10 (Columns 4-7) Contribution of Technology, Physical Capital, and Human Capital to the Growth of GDP per Hour Worked in the United States between 1950 and 2007.


Data: These data can then be converted into growth contributions of physical capital (K), human capital (H), and technology (A) to the annual growth rate of GDP per worker.

7 Economic Growth


7 Economic Growth

Exhibit 7.11 Share of Technology, Physical Capital, and Human Capital in the Growth of GDP per Hour Worked in the United States Between 1950 and 2007


Evidence-Based Economics Example

Question: Why are you so much more prosperous than your great-great-grandparents were?

Answer: In most decades, technology accounts for the bulk of growth in U.S. GDP per worker.

Caveat: If we understate the contribution of physical or human capital to GDP, the contribution of technology may be exaggerated.

7 Economic Growth



The economic history of the world can be broken down into three distinct periods:

1. Pre-modern times: up to 1800

2. Industrial Revolution: 1800 to 1820

3. Post-Industrial Revolution: 1820 to present


Source: The Maddison Project, at http://www.ggdc.net/maddison/maddison-project/data.htm

11000150016001700182018211822182318241825182618271828182918301831183218331834183518361837183818391840184118421843184418451846184718481849185018511852185318541855185618571858185918601861186218631864186518661867186818691870187118721873187418751876187718781879188018811882188318841885188618871888188918901891189218931894189518961897189818991900190119021903190419051906190719081909191019111912191319141915191619171918191919201921192219231924192519261927192819291930193119321933193419351936193719381939194019411942194319441945194619471948194919501951195219531954195519561957195819591960196119621963196419651966196719681969197019711972197319741975197619771978197919801981198219831984198519861987198819891990199119921993199419951996199719981999200020012002200320042005200620072008200920100

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

World-Wide Average Real GDP per capita (2005 dollars)

$642

$1,217 $2,124

$10,753(2005 dollars)

$3,001

$846



Thomas Malthus, writing in 1798, argued that humankind was destined to live at the subsistence level—the minimum level of income per person necessary to survive.

According to the Malthusian cycle, any increase in income per capita above the subsistence level would lead to higher fertility rates.



The higher fertility rates would fuel higher population growth, which in turn would drive income per capita back down to the subsistence level.

Without any technological advances, pre-modern times were stuck in the Malthusian cycle of little to no sustained growth in income per capita.



Two trends led Britain and then other countries to break out of the Malthusian cycle.

First, the introduction of new machines and methods of production (Industrial Revolution) created the technological progress necessary for sustained growth.

The Industrial Revolution started in production and then moved on to transportation.



Second, the movement of people from rural agriculture to urban manufacturing led to a drop in fertility rates (demographic transition).



The post-industrial Revolution period has experienced sustained growth in income per capita due to dramatic innovations in transportation, communications, electricity, and computers.




GDP per capita is a measure of the average living standard of a nation but not the income of all individuals in that nation.

We therefore must look at the income inequality of a nation.

The following graph shows a measure of income inequality of the United States from 1910 to present.


Exhibit 7.12 Fraction of U.S. Aggregate Income Accruing to the Top 10% of Earners



What, then, is the relationship between economic growth and inequality?

The following graph plots the relationship between growth in GDP per capita and changes in the poverty rate (defined as the percentage of the population living under $1.25 per day).



Exhibit 7.13 The Relationship Between Growth and Change in Poverty in the Early 1990s and the Early 21st Century



Although the negative relationship does not prove that growth causes declining poverty, it does show that economic growth can provide an effective way of reducing poverty.
