Chapter 9 Economic Growth and Rising Living Standards The Meaning and Importance of Economic Growth Measuring Living Standards A country s standards of living is the level of economic well being its economy delivers Real gross domestic product per capita is the most straightforward way to measure a GDP per capita is the ratio of one aggregate real GDP to another the total population o Does not take account of how goods and services are distributed within the to its citizens nation s standard of living country Wealthy countries also do much better in terms of health care and literacy and eliminating extreme poverty In poor countries almost all production goes toward food and primitive housing Very is left for health care workplace safety or education other than for the small fraction of the population that is wealthy Growth is a high priority even among the most prosperous countries The rule of 70 tells us that if a variable is growing by X percent per year it will double in Small Differences and the Rule of 70 approximately 70 X years Growth Prospects The most successful countries are not only rich but steadily growing richer The poorest countries are not growing much at all get poorer What Makes Economies Grow The Determinants of Real GDP In any given year we can view real GDP as being determined by four numbers o The amount of output the average worker produces in an hour o The number of hours the average worker spends at the job o The fraction of the population that is working o The size of the population Labor productivity the output produced by the average worker in an hour Productivity Output per hour Total Output real GDP Total hours worked Productivity Average Hours Average Hours Total hours Total employment Employment Population Ratio The fraction of the population that is working EPR Total employment Population Combining the Determinants Real GDP Productivity x Average Hours x EPR x Population The Growth Equation population Economic growth a rise in real GDP per capita divide both sides of the equation by the Real GDP per capita Productivity x Average Hours x EPR Growth equation Growth rate of total output over any period of time o Change in Real GDP per capita change in Productivity change in Average Hours change in EPR o An increase of any of the things on the right can create a rise in living standards Over the last half century 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 Growth in the Employment Population Ratio EPR Increases only when total employment rises at a faster rate than the population With a given population greater total employment means an increase in the EPR and a rise in real GDP per capita Changes in Labor Supply and Labor Demand One cause of a rise in total employment is an increase in labor supply 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 Greater employment can also arise from an increase in labor demand When labor supply increases the wage rate falls When labor demand increases the wage rate rises Government and the EPR Increasing the Growth of Labor Supply Government can spur increases in labor supply through a variety of measures o Decrease in income tax rates a cut in the income tax rate can convince more people to seek jobs at any given wage shifting the labor supply curve rightward Significant increases in tax rates could decrease labor supply o Some economists advocate changes in government transfer programs to speed the growth in employment Transfer payments can create disincentives to work Payments decrease the overall hardship suffered from not working and because benefits are cut or taken away when someone begins working they lower the reward for working 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 The labor demand curve can also be affected by government policies Subsidies for education and training have helped to increase the skills of the labor force and made workers more valuable to potential employers Government also subsidizes employment more directly by contributing part of the wage when certain categories of workers are hired All else equal govt 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 the EPR as a Growth Strategy No nation today thinks of raising its EPR as a way to create sustained economic growth It is not the EPR but the percentage change in the EPR that creates economic growth To create ongoing economic growth the EPR must not only increase but continue to increase year after year Government policy can raise the EPR and so create an 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 in the Capital Stock The most important determinant of long run economic growth and the one that economists and policy makers focus on is rising productivity Increases in the amount of capital stock available for the average worker in the economy causes productivity to increase All else equal a rise in capital per worker the total capital stock divided by total employment causes labor productivity to rise o An increase in the capital stock shifts the production function upward because any given number of workers can produce more output if they have more capital to work with The rate of planned investment spending in the economy determines how fast the capital Investment and the Capital Stock stock rises Another flow variable involved in the capital investment relationship depreciation o Reduces the capital stock over time o As long as investment is greater than depreciation the capital stock will rise o For any rate of depreciation the greater the flow of investment spending the faster the rise in the capital stock For a given rate of depreciation and given total employment a higher rate of investment spending causes faster growth in capital per worker faster growth in productivity and faster growth in the average standard of
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