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ECON203 Principles of Macroeconomics

Week 6Topic: ECONOMIC GROWTH

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Lesson ObjectivesLesson ObjectivesTo learn aboutAfter studying these topics you should be able to:• Define and calculate the economic growth rate and

explain the implications of sustained growth.

• Describe the economic growth trend.

• Explain how population growth and labour productivity growth make potential GDP grow.

• Explain and measure of the sources of labour productivity of growth.

• Explain the policies designed to increase economic growth.

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Economic GrowthEconomic Growth

Economic Growth: It is a sustained expansion of production possibilities. It is not a temporary cyclical expansion and it is different from the rise in income.

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Economic GrowthEconomic Growth

When resources are employed efficiently, CI in each of the panels shows the possible combinations of consumer goods and capital goods that can be produced in a given year.

Points C and I depict the quantity of consumer and capital goods produced if all resources are used to produce that good, respectively.

Positive Economic growth is an outward shift of the PPF in each of the two panels.

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Calculating Growth RatesCalculating Growth RatesThe Economic Growth Rate refers the change in real GDP between two years.

100year) (previous GDP Real

year) (previous GDP Real - year)(current GDP Real

RateGrowth Economic

Example: If real GDP in the current year is $ 8.4 trillion and real GDP in the previous year was $ 8.0 trillion then Growth Rate of Real GDP = $ 8.4 trillion - $ 8.0 trillion x 100 = 5%

$ 8.0 trillion .

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Sources of Economic Sources of Economic GrowthGrowth

Working age Population Labor force participation Average hours per worker

Working age Population Labor force participation Average hours per worker

Physical capital Human capital

•Education and training •Job experience

Technology

Physical capital Human capital

•Education and training •Job experience

Technology

Quantity of labor

Quantity of labor

Labor productivity

Labor productivity

Total Output (Real GDP)

Total Output (Real GDP)

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Productivity Productivity Productivity measures how efficiently resources are employed. The higher the productivity, the more goods and services that can be produced from a given amount of resources defined as the ratio of total output divided by the amount of a particular kind of resource employed.

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Productivity Productivity

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Labor Productivity Labor Productivity Capital is the most responsible resource for increasing labor productivity. New Technology is another factor that increase labor productivity.

Two broad categories of capitalHuman CapitalAccumulated knowledge, skill, (come from education and training) and experience of the labor force. As individual workers acquire more human capital, their productivity and income increasePhysical CapitalIncludes the machines, buildings, roads, airports, communication networks and other manufactured creations used to produce goods and services.

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Labor Productivity Labor Productivity

y

k

PF

0Capital per worker

Expresses the relationship between the amount of capital per worker (horizontal axis) and the output per worker (vertical axis), other things constant (level of technology).

Expresses the relationship between the amount of capital per worker (horizontal axis) and the output per worker (vertical axis), other things constant (level of technology).

Any point on the production function, PF, shows how much output per worker can be produced for a given amount of capital per worker.

Any point on the production function, PF, shows how much output per worker can be produced for a given amount of capital per worker.

When there are k units of capital per worker, average output per worker in the economy is y.

Upward slope of the curve occurs because an increase in capital per worker helps each worker produce more output (Simon Kuznets: 1/10 of the increase in economic growth).

Out

put

per

wor

ker

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Impact of Technology on Impact of Technology on Labor Productivity Labor Productivity

Ou

t pu

t p

er

wo

r ke

ry

0Capital per worker

PFy'

PF'

Technological change usually improves the quality of capital and increases productivity, shown by the upward rotation from PF to PF' more output is produced at each level of capital per worker (Simon Kuznets: 9/10 of the increase in economic growth).

Technological change usually improves the quality of capital and increases productivity, shown by the upward rotation from PF to PF' more output is produced at each level of capital per worker (Simon Kuznets: 9/10 of the increase in economic growth).

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Standard of livingStandard of living

The Real GDP (Output) per capita is the best measure of economy’s standard of living. Because it indicates how much an economy produces on average per person.

Real GDP per person = Real GDP/ population .

Real GDP per person grows only if real GDP grows faster than the population grows.

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Preconditions for Economic Preconditions for Economic Growth Growth

An incentive system is requires for Economic Growth that created by economic freedom, property rights , and markets. These three also depends on political stability.http://www.youtube.com/watch?v=y8HPZElenO8http://www.youtube.com/watch?v=RAoMHt28gfM

Economic Freedom refers a condition in which people are able to make personal choices, and they are free to buy and sell in the markets.

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Preconditions for Economic Preconditions for Economic Growth Growth

Property rights refers the social arrangements that rule the protection of private property. Property rights include the rights to physical property, financial property, and intellectual property. Property rights provide the people with the incentive to work & save.

Markets refers a place where buyers and sellers get information and do business with each other, and where market prices send signals to buyers and sellers that create incentive to increase quantities demanded and supplied. Free markets enable people to trade, save, and invest.

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Preconditions for Economic Preconditions for Economic Growth Growth

The previous three conditions (economic freedom, property rights, and markets) work together to create incentives for people to: a.specialize and tradeb.save and investc.expand their human capital, and d.discover and apply new technologies.

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Policies to achieve Faster Policies to achieve Faster Economic Growth Economic Growth

To achieve faster economic growth we must increase: 1.The growth rate of capital per hour of labor or2.The pace of technological change. The main suggestions for achieving these objectives are:a)Encourage (Stimulate) Savingb)Encourage (Stimulate) Research and Developmentc)Encourage International Traded)Improve the Quality of Educatione)Create incentive mechanisms

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Encourage (Stimulate) Encourage (Stimulate) SavingSaving

In general, saving finances investment, which brings capital accumulation. It means that encouraging saving can increase the growth of capital which turn to economic growth.

Higher saving rates higher growth rates

One way to increase saving is to make tax

incentives. Less tax More saving.

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Encourage Research and Encourage Research and DevelopmentDevelopment

Since technological change is the fruit of research and development (R&D), investment in R&D reflects the economy’s efforts to improve productivity.

Government subsidies and direct funding might stimulate basic research and development.

Private organizations are funding for applied research such as Apple Computer, iPhone, etc.

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Encourage International Encourage International TradeTrade

Free international trade stimulates economic growth by extracting all the available gains from specialization and trade.

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Improve the Quality of Improve the Quality of EducationEducation

By funding basic education and by ensuring high standards in skills such as language, mathematics, and science, governments can contribute enormously to a nation`s growth potential.

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Create incentive Create incentive mechanismsmechanisms

Economic growth occurs when the incentives to save , invest ,and innovate are strong enough. These incentives require property rights enforced by a well – functioning legal system.

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Now it’s over for Now it’s over for today. Do you have today. Do you have any question?any question?