UMD ECON 201 - Chapter 9: Economic Growth and Rising Living Standards

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Principles of MacroeconomicsChapter 9: Economic Growth and Rising Living Standards Vocabulary1. Technological Change: the invention and use of new inputs, new outputs or new production methods2. Investment Tax Credit: a reduction in taxes for firms that invest in new capital 3. Catch-Up Growth: economic growth, primarily in less-advanced countries, based on increasing capital per worker from low levels, and adopting technologies already used in more advanced countries4. Capita per Worker: the total capital stock divided by total employment5. Growth Equation: an equation showing the percentage growth rate of real GDP per capita as the sum of the growth rates of productivity, average hours, and the employment-population ratio6. Supply-Side Effects: macroeconomic policy effects on total output that work by changing the quantities of resource available7. Capital Gains Tax: a tax on profits earned when a financial asset is sold at more than its acquisition price 8. Labor Productivity: the output produced by the average worker in an hour 9. Discovery-Based Growth: economic growth, primarily in advanced countries, based on technological change from new discoveries 10. Corporate Profits Tax: a tax on profits earned by corporations 11. Consumption Tax: a tax on the part of their income that households spend Notes The Meaning and Importance of Economic Growth Introduction- Economic growth refers to a rise in the standard of living in a country.Measuring Living Standards- A county’s standard of living is the level of economic well-being its economy delivers to its citizens. - Real gross domestic product per capita (or real GDP divided by the population) is most used to measure the standard of living. o Reminder: GDP does not take account of how goods and services are distributed within the country. Because of this, GDP per capita is an imperfect measure of average living standards. Small Differences and the Rule of 70- The Rule of 70 tells us that if a variable is growing by X percent per year, it will double in approximately 70/X years.o Example: Let’s apply this rule to U.S. economic growth. If real GDP per capita continues to grow at 2 percent per year, living standards in the United States would double in about 70/2 = 35 years.Growth Prospects- Is growth a realistic prospect for poor countries? o Yes. The poor can become rich. Consider: South Korea, Singapore, Hong Kong and Taiwan- Why is Figure 1 deceptive for the poorest countries?o Scale of vertical axis  causes the growth paths for the poorest countries to be scrunched up near the bottomo Countries were left out- Figure 2 addressed both issues in Figure 1 by leaving out the richest countries entirely and adds in two countries that have had impressive recent success. What Makes Economies Grow?Introduction- Real GDP per capita is a fraction. Real GDP is the numerator and population is the denominator. o Real GDP > Population = Output per person riseso Real GDP < Population = Output per person rises. The Determinants of Real GDP- The real GDP is determined by four numbers:o The amount of output the average worker produces in an hour (productivity)o The number of hours the average worker spends at the job (average hours)o The fraction of the population that is working (employment-population ratio)o The size of the population- Productivityo The amount of output the average worker produces in an hour is called labor productivity, or just productivity. o Productivity = Output per hour = Total output / Total hours workedo Increases in productivity are one of the most important contributors to economic growth.- Average Hourso Average Hours = Total hours / Total employment- The Employment-Population Ratio (EPR)o EPR = Total employment / Population- Combining the Determinants o Real GDP = Productivity x Average hours x EPR x Population The Growth Equation- To find real GDP per capita, we divide both sides of the previously stated equation by the population.o Real GDP per capita = Productivity x Average Hours x EPR- Note: If two variables A and B are multiplied together, then the percentage change in their product is approximately equal to the sum of their percentage changes. Therefore, the growth rate of total output over any period of time is:o %Δ Real GDP per capita ≈ %Δ Productivity + %Δ Average Hours + %Δ EPRo This equation is called the economy’s growth equation. It shows the percentage growth rate of real GDP per capita as the sum of the growth rates of productivity, average hours, and the employment-population ratio.- Average hours have been trending downward over the last half-century, tending toreduce any rise in real GDP per capita from the other determinants. This trend is driven by shorter workdays and longer vacations. Growth in the Employment-Population RatioIntroduction- With a given population, greater total employment means an increase in EPR, anda rise in real GDP per capita.Changes in Labor Supply and Labor Demand-When labor supply increases, employment rises and the wage rate falls. -When labor demand increases, employment and the wage rate rises.-Increase in LD > Increase in LS-For a given population, the rise in total employment would increase the EPR, and the rise in total output would increase real GDP per capita. Government and the EPR- Based on current forecasts (shrinking EPR), the EPR will not be contributing to economic growth.- Increasing the Growth of Labor Supplyo The government can:  Decrease income tax rates Change government transfer programs (welfare, food stamps, unemployment benefits, social security retirement benefits) o A cut in tax rates increases the reward for working, while a cut in certain benefit programs increases the hardship of not working. All else equal, either policy can increase labor supply and employment, raising the EPR and real GDP per capita.- Increasing the Growth of Labor Demando All else equal, government policies that help increase the skills of the workforce or that subsidize employment more directly increase labor demand and employment, raising the EPR and real GDP per capita. The Limits to EPR as a Growth Strategy - The government policies targeting a rise in EPR will at best, create a short-lived burst of growth. o Why? The percentage change rather of EPR is what creates economic growth. To create ongoing economic growth, EPR must not only increase, but continue to increase, year after year. - Government policy can raise the EPR and create economic


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UMD ECON 201 - Chapter 9: Economic Growth and Rising Living Standards

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