Chapter 20: Economic Growth

Economic Growth, Standards of Living, Capacity, Economic Policies, Opportunity Costs

What is Economic Growth?

  • Economists’ Definition: An increase in the capacity to produce. Capacity is how much we can produce if we use all our resources. They use terms like full-employment real GDP, full-employment output, or the potential level of real GDP to refer to the amount we can produce when at full capacity. To economists, ‘economic growth’ is used to describe a movement of the production possibilities frontier.
  • Journalists’ Definition: When news reporters worry about too much or too little economic growth, what they really mean is too much or too little change in total spending. They’re referring to movement to & away from the frontier. They mean the booms and recessions and temporary increases and decreases in real GDP.

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What is the Rule of 72?

Divide 72 by the rate of annual percentage change of a variable to get the approximate number of years it takes for the variable to double. For example, at a 4% growth rate, real GDP would double every 18 years (72/4=18).

What Causes Growth?

  • Convince more people to move to your country.
  • Use government spending & hiring to decrease unemployment.
  • Make it easier to start a business in your country.
  • Increase the quality of your country’s schools or on-the-job training.
  • Provide incentives for business to invest in capital goods like factories, machines, or computers.
  • Encourage businesses to invest in research & development, so that they can make more or better goods with the same investments.
  • Lower taxes on your country’s workers so that they have an incentive to work more.
  • Discover new natural resources in or around your country.

There are examples of moving towards the PPF instead of expanding the PPF itself. Discovering more natural resources can be useful, but is not always an option.

Population growth is an increase in capacity, but it’s a double-edged sword. If new workers produce on average only what current workers produce, we will not have more output per person. In other words, we will not be better off. In addition, there may be other costs, including environmental costs or increased congestion.

What is Productivity?

Amount of output produced per hour of work. Economists refer to this because it allows them to talk about how much is produced per unit of labor, & distinguish increases in capacity to produce per person from simple increases in the number of workers. This also means that policies which increase output by convincing the same workers to work more hours aren’t true increases in productivity.

3 Primary Ways Productivity Improves

  • Increase in Physical Capital: More factories mean workers have more capital to work with.
  • Increase in Human Capital: The skills and education that make workers more productive. Human capital has the smallest effect on productivity.
  • Technology Improvements: Technology is generally refers to the knowledge of the best & most efficient ways to produce various goods and services. This is main driver for productivity change.

Policies that Increase Physical Capital

  • Incentives to invest in desirable physical capital projects. This can include security of property right & political stability in your country to increase foreign direct investment.
  • Incentives for people to save more (since this would reduce interest rates & increase investment).

Policies that Increase Human Capital

  • Invest in the education of the workforce (via apprenticeships, on-the-job training, etc.).

Policies that Improve Technology

Most difficult to affect using public policy but there are some ways to encourage it:

  • Develop a system of patents & copyright. This encourages large R&D projects.
  • Increase spending on R&D.
  • Developing countries have a unique opportunity to have immense real GDP growth, by adopting already existing advanced technology. This would allow them to “catch up”.

What are the Costs to Economic Growth?

  • Opportunity Costs: The primary costs of economic growth are opportunity costs. Generally speaking, to improve physical capital, human capital, or technology, we will need to forego other uses of our resources. The cost of increasing investment, if we’re at full capacity, is to give something else up or get more from abroad. When an individual chooses to save more, they must necessarily consume less today.
  • Environmental Costs: More production uses electricity, coal, oil & gas, which makes climate change worse.

Reasons for Slowing of Economic Growth

  • Growth in the working-age population has slowed over time.
  • The civilian labour force participation rate is falling year by year, as baby boomers retire.
  • Following the Great Recession, many workers became discouraged & stopped looking for jobs, or delayed entering the workforce.
  • On average, people have chosen to work fewer hours per week.
  • Productivity (output per hour) is growing slower than before.
  • Slowdowns in technological progress, especially for production technology (not consumption).
  • Less investment as a part of GDP.
  • Increased competition due to increased international trade.
  • Less effective education.
  • Increased regulation.
  • Rising oil prices (specifically during the 1970s slowdown).


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