Zara Mahmood September 17 13 EC102 Lecture 4 Growth Cont Human Welfare in the Short and Long Run Recession Real GDP per capita in the US falls by just one or 2 percentage points relative to the level of potential GDP o Even small differences in growth rates 1 2 points o Can lead to huge reductions in real per capita GDP of 20 or more in a decade Example India 1945 1995 average annual growth rate 1 3 o Would have taken Indian per capita GDP about 200 years to catch up to the current US level Since 1995 average annual growth rate 6 o At this rate India can achieve US per capita GDP in about 45 years Differences in Growth Rates Growth in One country over time Growth Differences across countries Since growth rates vary the country rankings can change over time Poor countries are not doomed to poverty forever o Singapore income low in 960 and now high Rich countries cant take their status for granted o May be overtaken by poorer but faster growing countries Sources of Economic Growth What causes economies to grow Key to growth productivity o How much stuff on average can be produced in an hour of work o Biggest difference between 100 years ago and now Productivity The quantity of goods and services that can be produced by one hour of work person hour one worker working one hour Productivity GDP person hours EG Country A produces 10B of GDP o 1B person hours of labor Country B produces 25B of GDP o With 5B person hours of labor Which country has higher productivity A 10 h B 5 hour Productivity A country s standard of living depends on its ability to produce g s Zara Mahmood September 17 13 EC102 Depends on productivity average quantity of g s produced per hour of labor input Y real GDP quantity of output produced Productivity Y L L number of labor hours Why Productivity is So Important When a nation s workers are very productive real GDP is large an incomes are high When productivity grows rapidly so do living standards What determines productivity and growth rate o Capital Office buildings machinery factories tools Goods used to produce other goods o Technological Change How much is the technology changing What Caused the Productivity Slowdown from 1973 1994 No universally agreed answer but several hypotheses Productivity didn t really slow down o Only appeared to slow down due to measurement problems Difficult measuring productivity in the production of services which became a bigger part of the economy in the 1970s Difficulty measuring improvements in health and safety o Deterioration of the US educational system Productivity in the US Can the United States maintain high rates of productivity growth Some economists argue that the development of a new economy based on information technology caused the higher productivity growth that began in the mid 1990s and many expect it to continue Others are skeptical arguing that by the early 2000s it will slow down Physical Capital Per Worker The stock of equipment and structures used to produce g s is called physical capital K L denotes the number of labor hours worked Capital per labor hour average K L o Productivity is higher when the average worker has more capital machines equipment to work with o Ie an increase in K L causes an increase in Y L Human Capital Per Worker Human Capital The knowledge and skills workers acquire through education training and experience Productivity is higher when the average worker has more human capital Zara Mahmood September 17 13 EC102 Technological Change Technology What processes a firm uses to turn inputs into outputs Technological Change Is an increase in Three Sources of Technological Change Better machinery and equipment Better organization and management of production Increase in human capital The Per Worker Production Function The relationship between real GDP per hour worked and capital per hour worked holding the level of technology constant If workers have little K giving them more increases their productivity a lot If workers already have a lot of K giving them more increases productivity fairly little Technological change helps economies overcome diminishing marginal o Advances in technology help overcome diminishing returns graph o Diminishing returns returns of capital shifts up Bowed diminishing returns Shifts up technological change Zara Mahmood September 17 13 EC102