Principles of Macroeconomics Chapter 9 Economic Growth and Rising Living Standards Vocabulary 1 Technological Change the invention and use of new inputs new outputs or new production methods 2 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 countries 4 Capita per Worker the total capital stock divided by total employment 5 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 ratio 6 Supply Side Effects macroeconomic policy effects on total output that work by changing the quantities of resource available 7 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 delivers to its citizens A county s standard of living is the level of economic well being its economy 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 bottom o 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 rises o 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 Productivity o 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 worked o Increases in productivity are one of the most important contributors to economic growth Average Hours o 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 Real GDP per capita Productivity Average Hours EPR o 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 to reduce 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 Ratio Introduction a rise in real GDP per capita Changes in Labor Supply and Labor Demand With a given population greater total employment means an increase in EPR and 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 Supply o 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 Demand o 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 growth temporarily while the EPR is rising But significant sustained economic growth would require significant sustained growth in the EPR which is not realistic Productivity Growth Increases
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