Economic growth in the global economy

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to accompanyto accompanyExploring EconomicsExploring Economics

33rdrd Edition Editionby Robert L. Sextonby Robert L. Sexton

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A Lecture PresentationA Lecture Presentation


Economic Growth in the Economic Growth in the Global EconomyGlobal Economy

Chapter 19Chapter 19


19.1 Economic Growth19.1 Economic Growth John Maynard KeynesJohn Maynard Keynes

primarily concerned with explaining and primarily concerned with explaining and reducing short‑term fluctuations in the level reducing short‑term fluctuations in the level of business activityof business activity

once said, “in the long run we are all dead.” once said, “in the long run we are all dead.” He wanted to smooth out the business He wanted to smooth out the business

cycle, largely because of the implications cycle, largely because of the implications that cyclical fluctuations had for buyers that cyclical fluctuations had for buyers and sellers in terms of unemployment and sellers in terms of unemployment and price instability. and price instability.


Short Run Versus Long RunShort Run Versus Long Run Keynes’ concerns were important Keynes’ concerns were important

and legitimate.and legitimate. At the same time, his flippant remark At the same time, his flippant remark

about the long run ignores the fact about the long run ignores the fact that human welfare is greatly that human welfare is greatly influenced by long-term changes in influenced by long-term changes in a nation's capacity to produce goods a nation's capacity to produce goods and services. and services.


Emphasis on the short-run business Emphasis on the short-run business

cycle ignores the longer term cycle ignores the longer term dynamic changes that affect output, dynamic changes that affect output, leisure, real incomes and life styles. leisure, real incomes and life styles.

Many would argue that in the long Many would argue that in the long run, economic growth is a crucial run, economic growth is a crucial determinant of well-being.determinant of well-being.


What are the determinants of long-run What are the determinants of long-run economic change in our ability to produce economic change in our ability to produce goods and services? goods and services?

What are some of the consequences of What are some of the consequences of rapid economic change? rapid economic change?

Why are some nations rich while others are Why are some nations rich while others are poor? poor?

Does growth in output improve our Does growth in output improve our economic welfare? economic welfare?


Defining Economic GrowthDefining Economic Growth Economic growthEconomic growth is usually is usually

measured by the annual percent measured by the annual percent change in real output of goods and change in real output of goods and services per capita (real GDP per services per capita (real GDP per capita). capita).

Along the production possibilities Along the production possibilities curve, the economy is producing at its curve, the economy is producing at its potential output. potential output.


How much the economy will produce How much the economy will produce at its potential output, sometimes at its potential output, sometimes called its natural level of output, called its natural level of output, depends on the quantity and quality depends on the quantity and quality of an economy’s resources, including of an economy’s resources, including labor, capital, and natural resources. labor, capital, and natural resources.


13.1 Economic Growth13.1 Economic Growth Technology can increase the Technology can increase the

economy’s production capabilities.economy’s production capabilities. Improvements in and greater stocks of Improvements in and greater stocks of

land, labor, and capital can shift out land, labor, and capital can shift out the production possibilities curve. the production possibilities curve.

Another way of saying that economic Another way of saying that economic growth has shifted the production growth has shifted the production possibilities curve out is to say that possibilities curve out is to say that growth has increased potential output.growth has increased potential output.



The Rule of 70The Rule of 70 A nation with greater economic growth will A nation with greater economic growth will

end up with a much higher standard of end up with a much higher standard of living, living, ceteris paribus.ceteris paribus.

The The Rule of 70Rule of 70 can tell how long it will can tell how long it will take a nation to double its output. take a nation to double its output. The number of years necessary is The number of years necessary is

approximately equal to the nation’s growth rate approximately equal to the nation’s growth rate divided into 70. For example, if a nation grows divided into 70. For example, if a nation grows at 3.5% per year, then the economy will double at 3.5% per year, then the economy will double every 20 years (70/3.5)every 20 years (70/3.5)


The “richest” or “most-developed” The “richest” or “most-developed” countries today have many times the countries today have many times the per capita output of the “poorest” or per capita output of the “poorest” or “least-developed” countries.“least-developed” countries.

The international differences in The international differences in income, output, and wealth are income, output, and wealth are striking and have caused a great deal striking and have caused a great deal of friction between developed and of friction between developed and less-developed countries.less-developed countries.


Standard of living is closely correlated with Standard of living is closely correlated with productivity growthproductivity growth

ProductivityProductivity is the amount of good and is the amount of good and services a worker can produce per hourservices a worker can produce per hour

Slow growth of capital investment can lead to Slow growth of capital investment can lead to lower labor productivity and consequently lower lower labor productivity and consequently lower wageswages

While increases in productivity, and While increases in productivity, and consequently higher wages, can occur as a consequently higher wages, can occur as a result of carefully crafted economic policies—result of carefully crafted economic policies—tax policies that stimulate investment or tax policies that stimulate investment or programs that encourage R&D. programs that encourage R&D.


The link between productivity and the The link between productivity and the standard of living can be easily understood standard of living can be easily understood by recalling our circular flow model.by recalling our circular flow model.

In the circular flow model aggregate values In the circular flow model aggregate values of all goods and services produced in the of all goods and services produced in the economy must equal the payments made economy must equal the payments made to the factors of production.to the factors of production.

So the only way an economy can increase So the only way an economy can increase its rate of consumption in the long run is if its rate of consumption in the long run is if they increase the amount they produce.they increase the amount they produce.



19.2 Determinants of19.2 Determinants of Economic Growth Economic Growth

Many separate explanations of economic Many separate explanations of economic growth have been proposed, but none of growth have been proposed, but none of them, by themselves, can completely them, by themselves, can completely explain economic growth. explain economic growth.

However, each of the explanations may However, each of the explanations may be part of a more complicated reality. be part of a more complicated reality.

Economic growth is a complex process Economic growth is a complex process involving many important factors, no involving many important factors, no one of which completely dominates. one of which completely dominates.


Nearly everyone agrees that several Nearly everyone agrees that several factors have contributed to economic factors have contributed to economic growth in some or all countries.growth in some or all countries. growth in the quantity and quality of growth in the quantity and quality of

labor resources usedlabor resources used increase in the use of inputs provided increase in the use of inputs provided

by land by land growth in physical capital inputs growth in physical capital inputs technological advances allowing greater technological advances allowing greater

output than previously possibleoutput than previously possible


Labor is needed in all forms of Labor is needed in all forms of productive activity. productive activity.

Other things being equal, an increase Other things being equal, an increase in labor input does not necessarily in labor input does not necessarily increase output per capita. increase output per capita.


If the increase in labor input results If the increase in labor input results from an increase in population, per from an increase in population, per capita growth might not occur capita growth might not occur because the increase in output could because the increase in output could be offset by the increase in be offset by the increase in population.population.


If a greater proportion of the If a greater proportion of the population works or if workers put population works or if workers put in longer hours, output per capita in longer hours, output per capita will increase—assuming that the will increase—assuming that the additional work activity adds additional work activity adds something to output. something to output.


Qualitative improvements in workers Qualitative improvements in workers (learning new skills, for example) can (learning new skills, for example) can also enhance output. also enhance output.

It has become popular to view labor It has become popular to view labor as "human capital" that can be as "human capital" that can be augmented or improved by education augmented or improved by education and on‑the‑job training.and on‑the‑job training.


Abundant natural resources also can Abundant natural resources also can enhance output whereas a limited enhance output whereas a limited resource base is an important resource base is an important obstacle to economic growth. obstacle to economic growth.


Resources are not the whole story. Resources are not the whole story. The natural resource base can affect The natural resource base can affect

the initial development process, but the initial development process, but sustained growth is influenced by other sustained growth is influenced by other factors. factors.

There is nearly universal agreement There is nearly universal agreement that capital formation has played a that capital formation has played a significant role in the economic significant role in the economic development of nations. development of nations.


Technological advances stem from Technological advances stem from man's ingenuity and creativity in man's ingenuity and creativity in developing new ways of combining developing new ways of combining the factors of production to enhance the factors of production to enhance the amount of output from a given the amount of output from a given quantity of resources. quantity of resources.

It involves invention and innovation. It involves invention and innovation. InnovationInnovation is the adoption of a new is the adoption of a new

product or process. product or process.


New technology must be introduced New technology must be introduced into productive use by managers or into productive use by managers or entrepreneurs who must weigh their entrepreneurs who must weigh their estimates of benefits of the new estimates of benefits of the new technology against their estimates technology against their estimates of costs. of costs.

The entrepreneur is an important The entrepreneur is an important economic factor in the growth economic factor in the growth process.process.


Technological advances permit us to Technological advances permit us to economize on one or more inputs used economize on one or more inputs used in the production process.in the production process.

It can permit savings of labor, as It can permit savings of labor, as occurs when a new machine is occurs when a new machine is invented that does the work of invented that does the work of many workers. many workers.

It can also be land (natural resource) It can also be land (natural resource) saving or even capital saving. saving or even capital saving.


Nuclear fission has permitted us to Nuclear fission has permitted us to build power plants that economize on build power plants that economize on the use of coal, a natural resource. the use of coal, a natural resource.


The reduction in transportation time The reduction in transportation time that accompanied the invention of the that accompanied the invention of the railroad allowed businesses to reduce railroad allowed businesses to reduce the capital they needed in the form of the capital they needed in the form of inventories.inventories. Because goods could be obtained Because goods could be obtained

quickly, businesses could reduce the quickly, businesses could reduce the stock kept on their shelves. stock kept on their shelves.


19.3 Raising the Level of19.3 Raising the Level of Economic Growth Economic Growth

Economic growth means more than an Economic growth means more than an increase in the real income (output) of increase in the real income (output) of the population.the population.

Changes in output are accompanied by Changes in output are accompanied by a number of other important changes. a number of other important changes.

There are a number of policies that There are a number of policies that a nation can pursue to increase a nation can pursue to increase economic growth.economic growth.


Saving Rates, Investment, Capital Saving Rates, Investment, Capital Stock, And Economic GrowthStock, And Economic Growth

One of the most important One of the most important determinants of economic growth determinants of economic growth is the saving rate. is the saving rate. In order to consume more in the future, In order to consume more in the future,

we must save more now. we must save more now. Generally speaking, higher levels of Generally speaking, higher levels of

saving will lead to higher levels of saving will lead to higher levels of investment and capital formation and, investment and capital formation and, therefore, to greater economic growth.therefore, to greater economic growth.


Sustained rapid economic growth is Sustained rapid economic growth is associated with high rates of saving associated with high rates of saving and investment around the world. and investment around the world.

Investment alone does not guarantee Investment alone does not guarantee economic growth, which hinges economic growth, which hinges importantly on the quality and the importantly on the quality and the type of investment as well as on type of investment as well as on investment in human capital and investment in human capital and improvements in technology.improvements in technology.



Research And DevelopmentResearch And Development Some scholars believe that the Some scholars believe that the

importance of importance of research and research and development (R&D)development (R&D) is understated. is understated.

It can include It can include new productsnew products management improvementsmanagement improvements production innovations production innovations simply learning by doingsimply learning by doing


It is clear that investments in R&D It is clear that investments in R&D and rewarding innovators with and rewarding innovators with patents has paid big dividends in patents has paid big dividends in the past 50 to 60 years. the past 50 to 60 years.


There is an important link between There is an important link between research and development and research and development and capital investment. capital investment.

When capital depreciates over time, it When capital depreciates over time, it is replaced with new equipment that is replaced with new equipment that embodies the latest technology.embodies the latest technology. Consequently, R&D may work hand-in-Consequently, R&D may work hand-in-

hand with investment to improve growth hand with investment to improve growth and productivity.and productivity.


The Protection Of Property Rights The Protection Of Property Rights Impacts Economic GrowthImpacts Economic Growth

Economic growth rates tend to be Economic growth rates tend to be higher in countries where the higher in countries where the government enforces property rights.government enforces property rights.

In most developed countries, property In most developed countries, property rights are effectively protected by the rights are effectively protected by the government, but government, but in developing countries, this is not in developing countries, this is not normally the case. normally the case.


And if the government is not enforcing And if the government is not enforcing property rights, the private sector property rights, the private sector must respond in costly ways that stifle must respond in costly ways that stifle economic growth.economic growth. private security private security bribes bribes corruption corruption confiscation confiscation the risk of takeovers from a new the risk of takeovers from a new

governmentgovernment


Free Trade And Economic Free Trade And Economic GrowthGrowth

Free trade can lead to greater output because Free trade can lead to greater output because of the principle of comparative advantage.of the principle of comparative advantage. If two nations or individuals with different If two nations or individuals with different

resource endowments and production resource endowments and production capabilities specialize in producing a smaller capabilities specialize in producing a smaller number of goods and services, then they number of goods and services, then they are relatively better at and engage in trade.are relatively better at and engage in trade.

Both parties will benefit as total output Both parties will benefit as total output rises.rises.


EducationEducation Education, investment in human Education, investment in human

capital, is just as important as capital, is just as important as improvements in physical capital.improvements in physical capital.

Accepting a reduction in current Accepting a reduction in current income to acquire education and income to acquire education and training can increase future earning training can increase future earning ability, which can raise the standard ability, which can raise the standard of living.of living.


With economic growth, illiteracy rates fall With economic growth, illiteracy rates fall and formal education grows. and formal education grows.

The correlation between per capita output The correlation between per capita output and the proportion of the population that and the proportion of the population that is unable to read or write is striking. is unable to read or write is striking.

Improvements in literacy stimulate Improvements in literacy stimulate economic growth by reducing barriers to economic growth by reducing barriers to the flow of information and raise labor the flow of information and raise labor productivity.productivity.


Since children in developing countries Since children in developing countries are an important part of the labor force are an important part of the labor force at a young age, there is a higher at a young age, there is a higher opportunity cost of education in terms of opportunity cost of education in terms of forgone contribution to family income.forgone contribution to family income.

Education is a consequence of economic Education is a consequence of economic growth, becoming a consumption good, growth, becoming a consumption good, as well as a cause of economic growth, as well as a cause of economic growth, creating human capital.creating human capital.


19.4 Population and19.4 Population and Economic Growth Economic Growth

At the beginning of the English At the beginning of the English Industrial Revolution (around 1750), Industrial Revolution (around 1750), the world’s population was the world’s population was approximately 700 million.approximately 700 million.

It took 150 years (to 1900) for that It took 150 years (to 1900) for that population to slightly more than population to slightly more than double to 1.6 billion.double to 1.6 billion.

Just 64 years later (in 1964), it had Just 64 years later (in 1964), it had doubled again to 3.2 billion.doubled again to 3.2 billion.


Population Growth And Population Growth And Economic GrowthEconomic Growth

After another 40 years (in 2004), it After another 40 years (in 2004), it is likely that the population will have is likely that the population will have doubled yet again to more than 6.4 doubled yet again to more than 6.4 billion (the world population was 6.2 billion (the world population was 6.2 billion in 2001).billion in 2001).

We have had economic development We have had economic development amidst all this growth in population, amidst all this growth in population, but what role does population play in but what role does population play in economic growth?economic growth?


If population were to expand faster than If population were to expand faster than output, per capita output would fall; output, per capita output would fall; population growth would inhibit growth.population growth would inhibit growth.

With a larger population, however, With a larger population, however, comes a larger labor force.comes a larger labor force.

Certainly, very rapid population growthCertainly, very rapid population growth—more than 3 percent a year—did not —more than 3 percent a year—did not seem to impede U.S. economic growth in seem to impede U.S. economic growth in the mid-19the mid-19thth century. century.


U.S. economic growth until at least U.S. economic growth until at least World War I was accompanied by World War I was accompanied by population growth that was among population growth that was among the highest in the world for the time.the highest in the world for the time.

There is a general feeling that in There is a general feeling that in many of the developing countries many of the developing countries today, rapid population growth today, rapid population growth threatens the possibility of attaining threatens the possibility of attaining sustained economic growth.sustained economic growth.


These countries are predominantly These countries are predominantly agricultural with very modest natural agricultural with very modest natural resources, especially land. The land-resources, especially land. The land-labor ratio is very low.labor ratio is very low.

Why is population growth a threat in Why is population growth a threat in these countries?these countries?


The Malthusian PredictionThe Malthusian Prediction Malthus formulated a theoretical Malthus formulated a theoretical

model that predicted that per capita model that predicted that per capita economic growth would eventually economic growth would eventually become negative and that wages become negative and that wages would ultimately reach equilibrium would ultimately reach equilibrium at a subsistence level, or just large at a subsistence level, or just large enough to provide enough income enough to provide enough income to stay alive.to stay alive.


Malthus made three assumptions:Malthus made three assumptions:1.1. The economy was agricultural, The economy was agricultural,

with goods produced by two with goods produced by two inputs, land and laborinputs, land and labor

2.2. The supply of land was fixedThe supply of land was fixed3.3. Human sexual desires worked to Human sexual desires worked to

increase populationincrease population


The Law Of Diminishing The Law Of Diminishing Marginal ReturnsMarginal Returns

As population increases, the number As population increases, the number of workers increases, and with greater of workers increases, and with greater labor inputs available, output also labor inputs available, output also goes up.goes up.


A some point, however, output will A some point, however, output will increase by diminishing amounts increase by diminishing amounts because of the law of diminishing because of the law of diminishing returns, which states that you add returns, which states that you add variable amounts of one input (in this variable amounts of one input (in this case, labor) to fixed quantities of another case, labor) to fixed quantities of another input (in this case, land), output will rise input (in this case, land), output will rise but by diminishing amounts (because as but by diminishing amounts (because as the land-labor ration falls, there is less the land-labor ration falls, there is less land per worker).land per worker).


Avoiding Malthus’s PredictionAvoiding Malthus’s Prediction Malthus’s theory proved wrong for much Malthus’s theory proved wrong for much

of the world.of the world. The quantity or quality of cultivable land The quantity or quality of cultivable land

is not completely fixed.is not completely fixed. Malthus implicitly assumed there would Malthus implicitly assumed there would

be no technological advances and ignored be no technological advances and ignored the real possibility that improved the real possibility that improved technology could overcome the impact of technology could overcome the impact of the law of diminishing returns.the law of diminishing returns.


The Malthusian assumption that The Malthusian assumption that sexual desire would necessarily lead sexual desire would necessarily lead to population increase is not accurate to population increase is not accurate because the number of births can be because the number of births can be reduced by birth control techniques.reduced by birth control techniques.


In some countries, a larger population In some countries, a larger population may lead to more entrepreneurs, may lead to more entrepreneurs, engineers, and scientists who will engineers, and scientists who will contribute to even greater economic contribute to even greater economic growth through technological growth through technological progress.progress.


Do Some Developing Countries Still Do Some Developing Countries Still Fit Malthus’s Prediction Today?Fit Malthus’s Prediction Today?

Some developing nations of the world Some developing nations of the world are having substantial population are having substantial population increases, with a virtually fixed supply increases, with a virtually fixed supply of land, slow capital growth, and few of land, slow capital growth, and few technological advances.technological advances.

In fact, some have tried to reduce the In fact, some have tried to reduce the rate of population growth to achieve rate of population growth to achieve greater economic growth per capita greater economic growth per capita and higher standards of living.and higher standards of living.


While high population growth rates While high population growth rates may be one explanation for lower may be one explanation for lower standards of living, there are many standards of living, there are many non-Malthusian explanations for the non-Malthusian explanations for the recurring poverty that exists in recurring poverty that exists in developing countries today:developing countries today: Political instabilityPolitical instability Lack of defined and enforceable property Lack of defined and enforceable property

rightsrights Inadequate investment in human capitalInadequate investment in human capital
