ECON 1202 1st Edition Lecture 15 Outline of Last Lecture I. Business CycleII. Effects of Business Cycle on FirmsIII. Effects of Business Cycle on InflationIV. Effects of Business Cycle on UnemploymentV. Explaining the Great ModerationVI. Common Misconceptions to AvoidOutline of Current Lecture I. Economic Growth over Time and Around the WorldII. What Determines How Fast Economies Grow?III. Economic Growth in the USIV. Why Isn’t the Whole World Rich?Current LectureI. Economic Growth over Time and Around the Worlda. Economist Brad DeLong estimates that in 1,000,000 B.C., our ancestors had a GDP per capita of approximately $140.i. He estimates that GDP per capita in 1300 A.D. was also about $140.ii. In other words, no sustained economic growth occurred before the middle ages; a peasant on a farm in 1300 A.D. was about as well off his ancestors.b. Significant economic growth did not really begin until the Industrial Revolution, the application of mechanical power to the production of goods and services which began in England around 1750.i. Before this, production of most goods had relied on human or animal power.ii. The use of mechanical power allowed England and other countries—like the United States, France, and Germany—to begin to experience long-runeconomic growth.iii. The Industrial Revolution, and its subsequent spread throughout the world, resulted in sustained increases in real GDP per capita.c. In the long run, small differences in economic growth rates result in big differences in living standards.These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.d. Economists often refer to the high-income countries (or industrial countries) of Western Europe, Australia, Canada, Japan, New Zealand, and the United States, in comparison to the poorer developing countries of the rest of the world.II. What Determines How Fast Economies Grow?a. An economic growth model seeks to explain growth rates in real GDP per capita over the long run.b. The key to this is labor productivity: the quantity of goods and services that can be produced by one worker or by one hour of work.i. Two main factors affect labor productivity: 1. The quantity of capital per hour worked, and2. The level of technology.c. So our model will concentrate on changes in the quantity of capital, and technological change.i. Technological change: A change in the quantity of output a firm can produce using a given quantity of inputs.ii. There are three main sources of technological change:1. Better machinery and equipment- Inventions like the steam engine, machine tools, electric generators, and computers, have allowed faster economic growth.2. Increases in human capital- Human capital is the accumulated knowledge and skills that workers acquire from education and training, or from their life experiences.3. Better means of organizing and managing production- If managers can do a better job of organizing production, then labor productivity can increase. d. Production per Workeri. Per-worker production function: the relationship between real GDP per hour worked, and capital per hour worked, holding the level of technology constant. ii. The first units of capital would be the most effective, allowing output per hour to increase mostiii. Subsequent increases result in diminishing returns: smaller increases in output resulting from increasing one factor of production progressively higher while keeping the other factors of production constant.e. Role of Government in Knowledge Capital Generationi. Because firms do not enjoy the entire benefit of their knowledge capital, they do not produce enough of it.ii. The public good nature of knowledge capital leads to a role for government policy in:1. Protecting intellectual property with patents and copyrights- Allowing firms to benefit from their own research and development increases their incentive to perform it.- Patents are the exclusive right to produce a product for a period of 20 years from the date the patent is applied for. This period of time is designed to balance the chance for firm to benefit from its invention against the need of society to benefit from it.- Copyrights act similarly for creative works like books and films, granting the exclusive right to use the creation during and 70 years after the creator’s lifetime.2. Subsidizing research and development- Governments might perform research directly—like NASA and the National Institutes of Health—or subsidize researchers at institutions like universities.- Similarly, they can provide tax-incentives to firms performing R&D.3. Subsidizing education- In order to perform research and development, workers need to be technically trained. If firms provide this training, they recoup the cost by paying workers lower wages, decreasing the incentive for workers to take such jobs.- A solution to this is to have the government subsidize education, as it does in all high-income countries.III. Economic Growth in the USa. Growth rates in the United States were relatively modest prior to 1900.b. In the 20th century, firms and the U.S. government invested heavily in research and development, resulting in increasing growth rates.c. Growth rates remained high until the mid-1970s, when they fell unexpectedly, before picking up again in the mid-1990s.IV. Why Isn’t the Whole World Rich?a. The economic growth model predicts that poor countries will grow faster than rich countries.i. This is because:1. The effect of additional capital is greater, for countries with smaller capital stocks2. There are greater advances in technology immediately available topoorer countriesb. This leads to a prediction of catch-up: that the level of GDP per capita (or incomeper capita) in poor countries will grow faster than in rich countries.c. Why are high-income countries not catching the US?i. A combination of reasons explain this:1. U.S. labor markets are relatively flexible; hiring and firing workers is relatively unrestricted by government regulation.2. Similarly, American workers tend to enter the work force sooner and retire later than do workers in Europe.3. The U.S. financial system is relatively efficient, and the high volume of trading ensures high liquidity, making the U.S. an attractive place to invest.4. Small firms find obtaining capital relatively easy in the U.S. due to the advent of venture capital firms.d.