Chapter 9 cont.

Chapter 9: Economic Growth, the Financial System, and Business Cycles BUSINESS CYCLE: alternating periods of economic expansion and economic recession Each period of recession or expansion are not the same length LONG-RUN ECONOMIC GROWTH: the process by which rising productivity increases the average standard of living Best measure of standard of living is real GDP per person, usually referred to as real GDP per capita We measure long-run economic growth in real GDP per capita over long periods of time, generally decades or more We use real GDP rather than nominal GDP to adjust for changes in the price level over time In the long-run, the U.S. economy has experienced economic growth and in the short run, it has experienced a series of business cycles. Living standards in the U.S. have increased significantly because in the long-run, growth in the production of goods and services has been faster than growth in population. (i.e. real GDP per capita has increased) This is not the case in all countries Connection between economic prosperity and health Dramatic improvements in the nutrition of the average person due to: Improvements in agricultural technology Rising incomes Sharp declines in sickness due to waterborne diseases in the late nineteenth century due to: Development of the germ theory of disease Technological progress in the purification of water As people became taller, stronger, and less susceptible to disease, they became more productive Technological advance will continue to reduce the avg number of hours worked per day and the # of years the avg person spends in the workforce Countries with economic growth have seen increases in life expectancy Life expectancy at birth is expected to continue to rise 10 years by the middle of the century Calculating Growth Rates The average annual growth rate of real GDP for a 3 year period would be the average of the three annual growth rates. When discussing long-run economic growth, we usually shorten ?average annual growth rate? to ?growth rate? Rule of 70 We can judge how rapidly an economic variable is growing by calculating the number of years it would take to double Number of years to double = ____70_____ Growth rate Small differences in growth rates can have large effects on how rapidly the standard of living in a country increases Rule of 70 applies to growth in any variable (stock market investment) Increases in real GDP per capita depend on increases in labor productivity LABOR PRODUCTIVITY: quantity of goods and services that can be produced by one worker or by one hour of work -economists usually measure labor productivity as output per hour of work to avoid the effects workday length fluctuations and in the fraction of the population employed Economists believe two key factors determine labor productivity: Technological Change Economic growth depends more on tech change than increases in capital per hour worked Technological change is an increase in the quantity of output firms can produce using a given quantity of inputs Most technological change is embodied in new machinery, equipment, or software In implementing technological change, entrepreneurs are crucial Make decisions on whether to introduce new technology to produce better or lower-cost products Decide whether to allocate firm?s resources to research and development that can result in new technologies Increases in Capital Per Hour Worked Capital is manufactured goods that are used to produce other goods and services Capital stock is the total amount of physical capital available in a country As capital stock per hour worked increases, worker productivity increases. Secretary w/ a computer can produce more than a secretary w/ a typewriter Human capital refers to the accumulated knowledge and skills workers acquire from education and training or from their life experiences Workers with a college education generally have more skills and are more productive than workers with only a high school diploma One of the difficulties centrally planned economies have in sustaining economic growth is that managers employed by the gov are usually much slower to develop and adopt new technologies than entrepreneurs in a market system. An additional requirement for economic growth is that the gov provides secure rights to private property Government can help the market work and aid economic growth by establishing an independent court system that enforces contracts between private individuals Many economists would say the gov has a role in facilitating the development of an efficient financial systems, as well as systems of education, transportation, and communication Some argue that every country that has experienced economic growth first experienced a ?financial revolution? Because economists take a long-run perspective in discussing economic growth, the concept of potential GDP is useful. Potential GDP is the level of GDP attained when all firms are producing at capacity. The capacity of a firm is not the maximum output the firm is capable of producing. A plant?s capacity is measured by its production when operating on normal hours, using a normal workforce. If all firms in the economy were operating at capacity, the level of total production of final goods and services would equal potential GDP. Potential GDP will increase over time as the labor force grows, new factories and office buildings are built, new machinery and equipment are installed, and technological change takes place. Growth in potential real GDP in the U.S. is estimated to be about 3.5% per year. March 4, 2009 There is no guarantee that the rich will stay rich and the poor are not necessarily doomed to eternal poverty What is behind the large variation in standards of living across countries and over time? What determines the rate of long run growth? Productivity!! Long run growth is measured by real GDP per capita This rate depends on labor productivity Labor Productivity- Quantity of goods and services that can be produced by one worker or one hour of work Economists believe that two key factors determine labor productivity: Quantity of capital per hour worked Level of technology Capital- manufactured goods that are used to produce other goods and services ie- machinery The total amount of physical capital (such as computers, factory buildings, and trucks) available in a country is known as the country?s capital stock As the capital stock per hour worked increases, worker productivity increases Ie- write ten page research paper- with only paper pen and library, get more done if you had a computer and word processor? Capital is a produced factor of production, so a country can change its capital stock If a country produces a large quantity of capital goods today, then it will have a larger capital stock tomorrow, and it will be able to produce more of all types of goods and services tomorrow So, one way to increase future productivity is to devote more current resources to the production of capital However, there is an opportunity cost of doing so: when resources are used to produce capital goods, they cannot be used to produce consumption goods To increase future consumption society must sacrifice some current consumption If workers already have a large amount of capital to work with, then giving them an additional unit of capital will not increase their productivity by much In contrast, if workers have very little capital to begin with, then an additional unit of capital will increase their productivity by a lot IE doing everything by hand and then getting a computer- productivity is increased Catch up (chapter 10)- prediction that the level of GDP per capita will grow faster in poorer countries than in rich countries In recent decades some poor countries have grown faster than rich countries, but many have not There are four main reasons some poor countries do not experience rapid growth: Wars and revolutions Poor public education and health; there is a need to reduce disease and increase nutrition Failure to enforce the rule of law Rule of law- the ability of a government to enforce the laws of a country Property rights- rights of individuals or firms to have the exclusive use f their property (including being able to buy and sell it!) Low rates of saving and investment Economic growth depends more on technological change than on increases in capital per hour worked (important!) Main reason for this is because once you get to a certain level having more doesn?t make a difference until there is a change in technology Technology refers to the process a firm uses to turn inputs into outputs of goods and service Technological change- a change in the quantity of output that a firm can produce given an input Technological improvements come from 3 main sources Better machinery and equipment IE steam engine, computer Increases in human capital Human capital- the accumulated knowledge and skills that workers acquire from education or life experiences Human capital is a produced factor of production, so a country can change the amount of human capital that it has Unfortunately, investment in human capital has an opportunity cost: when students are in class they are not producing goods and services Again, to increase future consumption, society must sacrifice some current consumption Better means of organizing and managing production An economy will have a higher standard of living the more capital it has per hour worked, the more human capital its workers have, the better its capital and the better job its business managers do in organizing production In the long run, a country will experience an increasing standard of living only if it experiences continuing technological change