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Chapter 17 - Economic Growth and the New Economy

Introduction

  • Two definitions of economics growth were given in Chapter 8.
    • The increase in real GDP, which occurs over a period of time.
    • The increase in real GDP per capita, which occurs over time.This definition is superior if comparison of living standards is desired.
  • Growth has been impressive in capitalist countries during the past half century.Real GDP in the U.S. increased by 450 percent.
  • This chapter explores economic growth in more depth than Chapter 8.

Six Main Ingredients of Growth

  • Four supply factors relate to the ability to grow.
    • The quantity and quality of natural resources,
    • The quantity and quality of human resources,
    • The supply or stock of capital goods, and
    • Technology.
  • Two demand and efficiency factors are also related to growth.
    • Aggregate demand must increase for production to expand.
    • Full employment of resources and both productive and allocative efficiency are necessary to get the maximum amount of production possible.

Production Possibilities Analysis (Figure 17-1)

  • Growth can be illustrated with a production possibilities curve (Figure 17-1), where growth is indicated as an outward shift of the curve from AB to CD.
    • Aggregate demand must increase to sustain full employment at each new level of production possible.
    • Additional resources that shift the curve outward must be employed efficiently to make the maximum possible contribution to domestic output.
    • And for economy to achieve the maximum increase in monetary value, the optimal combination of goods must be achieved (allocative efficiency).
  • Focus on the supply side is illustrated in Figure 17-2, where growth depends on labor inputs multiplied by labor productivity.
    • Increased labor inputs depend on size of population and labor force participation rate (the percent of population actually in the labor force).
    • Productivity is determined by technological progress, the availability of capital goods, quality of labor itself, and efficiency with which inputs are allocated, combined, and managed.
  • Aggregate demand‑aggregate supply framework can also be used to illustrate growth, as seen in Figure 17-3.Aggregate supply shifts outward with economic growth, and in recent decades aggregate demand has shifted outward by an even greater amount.Nominal GDP rises faster than real GDP.(Key Question 3)
  • Extended AD-AD model is shown in figure 17-4 where short-term and long-term aggregate supply are differentiated in Figure 17-4.
    • Long-run potential output is shown at Q1.It depends on resources and productive efficiency.
    • If potential output increases, the long-run supply curve shifts from ASLR1 to ASLR2.
    • If aggregate demand rises from AD1 to AD2, real output rises to Q2 and prices to P2.
    • At P2 there will be a different short-run AS curve, AS2.
    • The result is some mild inflation and increases in real GDP.

Growth Record of the United States (Table 17-5)

  • Real GDP has increased more than sixfold since 1940, and real per capita GDP has risen by a multiple of three.
  • Rate of growth record shows that real GDP has grown 3.1 percent per year since 1948 and real GDP per capita has grown about 2 percent per year.In last four years of century, U.S. economic growth surged and averaged more than 4 percent per year.But the arithmetic needs to be qualified.
    • Growth doesn't measure quality improvements.
    • Growth doesn't measure increased leisure time.
    • Growth doesn't take into account adverse effects on environment.
    • International comparisons are useful in evaluating U.S. performance.For example, Japan has grown more than twice as fast as U.S. since 1948 (see Global Perspective 17-1) but less in past decade.

Accounting for growth is an attempt to quantify factors contributing to economic growth as shown in Table 17-1. Important research has been done in the area by Edward Denison.

  • More labor input is one source of growth.Labor force has grown about 2 million workers per year for past 25 years and accounts for about one-third of total economic growth.
  • Technological advance, the most important factor, has been estimated to contribute to about 26 percent of the U.S. growth record since 1929.
  • Increases in quantity of capital are estimated to have contributed 18% to economic growth in U.S. since 1929.
  • Education and training improve the quality of labor.(See Figure 17-6 and Table 17-1)
  • Improved resource allocation and economies of scale also contribute to growth and explain about 12% of total.
    • Improved resource allocation has occurred as discrimination disappears and labor moves where it is most productive, and as tariffs and other trade barriers are lowered.
    • Economies of scale occur as the size of markets and firms that serve them have grown.
  • Other factors influence growth and are more difficult to measure.
    • Social cultural environment and political stability are "growth friendly" in U.S.
      • Respect for material success provides incentive to increase incomes.
      • Market system rewards actions that increase output.
      • Property rights and legal system encourage growth.
      • Positive attitudes toward work and flow of energetic immigrants also add to growth.

Productivity Growth and the New Economy (Figure 17-7)

  • Improvement in standard of living is linked to labor productivity - output per worker per hour.
  • The U.S. is experiencing a resurgence of productivity growth based on innovations in computers and communications, coupled with global capitalism.Since 1995 productivity growth has averaged 2.9% annually - up from 1.4% over 1973-95 period."Rule of 70" projects real income will double in 23 years rather than 50 years.
  • Much recent improvement in productivity is due to "new economy" factors such as:
    • Microchips and information technology are the basis for improved productivity.Many new inventions are based on microchip technology.
    • New firms and increasing returns characterize the new economy.
      • Some of today's most successful firms didn't exist 25 years ago: Dell, Compaq, Microsoft, Oracle, Cisco Systems, America Online, Yahoo and Amazon.com are just a few of many.
      • Economies of sale and increasing returns in new firms encourage rapid growth. (See Table 17-1)
    • Sources of increasing returns include:
      • More specialized inputs.
      • Ability to spread development costs over large output quantities since marginal costs are low.
      • Simultaneous consumption of many customers at same time.
      • Network effects make widespread use of information goods more valuable as more use the products.
      • Learning increases with practice.
    • Global competition encourages innovation and efficiency.
    • Macroeconomic outcomes include increases in aggregate supply (shift to right).See Figure 17-3.
    • Faster growth without inflation is possible with higher productivity.
    • The natural rate of unemployment seems to be lower (4.5 - 5.0%).
    • Federal revenues increase with economic growth; a 1995 deficit of $160 billion became a $167 billion surplus in 2000.
    • Skepticism about long-term continued growth remains.

Is Growth Desirable and Sustainable?

  • An antigrowth view exists.
    • Growth causes pollution, global warming, ozone depletion, and other problems.
    • "More" is not always better if it means dead-end jobs, burnout, and alienation from one's job.
    • High growth creates high stress.
  • Others argue in defense of growth.
    • Growth leads to improved standard of living.
    • Growth helps to reduce poverty in poor countries.
    • Growth has improved working conditions.
    • Growth allows more leisure and less alienation from work.
    • Environmental concerns are important, but growth actually has allowed more sensitivity to environmental concerns and the ability to deal with them.
  • Is growth sustainable?Yes, say proponents of growth.
    • Resource prices are not rising.
    • Growth today has more to do with expansion and application of knowledge and information, so is limited only by human imagination.

LAST WORD: Some Pleasant Side Effects of the New Economy

  • Economists Jason Saving and W. Michael Cox point to other benefits of New Economy besides improved living standards.
  • Crime rates are down possible due to better job and income prospects.
  • Welfare rolls have fallen from 5.5% of U.S. population in 1995 to 2.5% in 1999.
  • Charitable contributions increased an average 9% annually, much higher than previous increases in giving.

Minority well being improved with decreased poverty and unemployment rates

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