CHAPTER 28

Long-Run Growth

Prepared by: Fernando

Quijano and Yvonn Quijano

2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Economic Growth

Economic growth refers to an increase in

the total output of an economy. Defined
by some economists as the increase of
real GDP per capita.
Modern economic growth is the period
of rapid and sustained increase in real
output per capita that began in the
Western World with the Industrial
Revolution.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Economic Growth

The production possibility

frontier shows all the
combinations of output that
can be produced if all
societys scarce resources
are fully and efficiently
employed.
Economic growth shifts
societys production
possibility frontier up and
to the right.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 The Growth Process:
From Agriculture to Industry
Before the Industrial Revolution in Great
Britain, every society in the world was
agrarian.
Beginning in England around 1750,
technical change and capital accumulation
increased productivity in two important
industries: agriculture and textiles.
More could be produced with fewer
resources, leading to new products, more
output, and wider choice.
2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 The Sources of Economic Growth

An aggregate production function is the

mathematical representation of the
relationship between inputs and national
output, or gross domestic product.
If you think of GDP as a function of both
labor and capital, you can see that an
increase in GDP can come about through:
1. An increase in the labor supply
2. An increase in physical or human capital
3. An increase in productivity
2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 An Increase in Labor Supply

An increasing labor supply can generate

more output, but if the capital stock
remains fixed, the new labor will be less
productive (diminishing returns).
Malthus and Ricardo predicted a gloomy
future as population outstripped the lands
capacity to produce. However, they forgot
the impact of technological change and
capital accumulation.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Economic Growth From
an Increase in Labor
Growth in the labor force, without a corresponding
increase in the capital stock or technological change
might lead to growth of output but declining productivity.
Economic Growth from an Increase in Labor More Output but
Diminishing Returns and Lower Labor Productivity
QUANTITY QUANTITY TOTAL MEASURED
OF LABOR OF CAPITAL OUTPUT LABOR
L K Y PRODUCTIVITY
PERIOD (HOURS) (UNITS) (UNITS) Y/L
1 100 100 300 3.0
2 110 100 320 2.9
3 120 100 339 2.8
4 130 100 357 2.7

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Economic Growth From
an Increase in Labor
Employment, Labor Force, and Population Growth, 1947 1999
CIVILIAN CIVILIAN
NONINSTITUTIONAL LABOR
POPULATION FORCE
OVER 16 YEARS Number Percentage EMPLOYMENT
OLD (Millions) of Population (MILLIONS)
(MILLIONS)

1947 101.8 59.4 58.3 57.0

1960 117.3 69.6 59.3 65.8
1970 137.1 82.8 60.4 78.7
1980 167.7 106.9 63.7 99.3
1990 189.2 125.8 66.5 118.8

1999 207.8 139.4 67.1 133.5

Percentage change, 1947 1999 + 104.1 + 134.7 + 134.2

Annual rate + 1.4% +1.7% + 1.7%
Source: Economic Report of the President, 2000, Table B-33.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Increases in Physical Capital

An increase in the stock of capital can increase

output, even if it is not accompanied by an
increase in the labor force.
Economic Growth from an Increase in Capital More Output, Diminishing
Returns to Added Capital, Higher Measured Labor Productivity
QUANTITY QUANTITY TOTAL MEASURED
OF LABOR OF CAPITAL OUTPUT LABOR
L K Y PRODUCTIVITY
PERIOD (HOURS) (UNITS) (UNITS) Y/L
1 100 100 300 3.0
2 100 110 310 3.1
3 100 120 319 3.2
4 100 130 327 3.3

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Increases in Physical Capital

The increase in capital stock is the

difference between gross investment and
depreciation.
Capital has been increasing faster than
the labor force since 1960. When capital
expands more rapidly than labor, the ratio
of capital to labor (K/L) increases, and this
too is a source of increasing productivity.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Increases in Physical Capital

Fixed Private Nonresidential Net Capital Stock, 1960 1998

(Billions of 1996 Dollars)
EQUIPMENT STRUCTURES
1960 672.5 2,047.7
1970 954.2 2,788.3
1980 1,988.9 3,646.3
1990 2,721.0 4,778.6
1998 3,797.3 5,389.2

Percentage change, 1960 1998 + 464.7 + 163.2

Annual rate + 4.7% + 2.6%
Source: Survey of Current Business, April 2000, computed from Tables 1 and 2, p. 21.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Increases in Human Capital

Years of School Completed by People Over 25 Years Old, 1940 1998

PERCENTAGE
WITH LESS PERCENTAGE PERCENTAGE
THAN 5 WITH 4 YEARS WITH 4 YEARS
YEARS OF OF HIGH SCHOOL OF COLLEGE
SCHOOL OR MORE OR MORE
1940 13.7 24.5 4.6
1950 11.1 34.3 6.2
1960 8.3 41.1 7.7
1970 5.5 52.3 10.7
1980 3.6 66.5 16.2
1990 NA 77.6 21.3
1998 NA 82.8 24.4
NA = not available.
Source: Statistical Abstract of the United States, 1990,
1990, Table 215; and 1999, Table 263.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Increases in Productivity

Growth that cannot be explained by

increases in the quantity of inputs can be
explained only by an increase in the
productivity of those inputs.
The productivity of an input is the
amount produced per unit of an input.
Factors that affect the productivity of an
input include technological change, other
advances in knowledge, and economies of
scale.
2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Increases in Productivity

Technological change affects productivity

in two stages:
First there is an advance in knowledge, or an
invention.
Then there is innovation, or the use of new
knowledge to produce a new product or to
produce an existing product more efficiently.
There are capital-saving innovations, and
labor-saving innovations.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Increases in Productivity

External economies of scale are cost

savings that result from increases in the
size of industries.
Production abatement requirements
divert capital and labor from the
production of measured output, therefore
reducing measured productivity.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Growth and Output in the United States

Growth of Real GDP in the United States, 1871 1999

AVERAGE AVERAGE
GROWTH GROWTH
RATE RATE
PERIOD PER YEAR PERIOD PER YEAR
1871-1889 5.5 1950-1960 3.5

1889-1909 4.0 1960-1970 4.2

1909-1929 2.8 1970-1980 3.2

1929-1940 1.6 1980-1990 3.2

1940-1950 5.6 1990-1999 3.1

Sources: Historical Statistics of the United States: Colonial Times to 1970,
1970, Tables F47-70, F98-124; U.S. Department of Commerce, Bureau of
Economic Analysis.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Growth and Output in the United States

Growth of Real GDP in the United States and

Other Countries, 1981 1998
AVERAGE
GROWTH RATE
COUNTRY PER YEAR
United States 3.1
Japan 2.8
Germany 2.1
France 2.0
Italy 1.8
United Kingdom 2.4
Canada 2.5
Africa 2.5
Asia (excluding Japan) 7.3
Source: Economic Report of the President, 2000,
2000, computed from Table B-110.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Sources of Growth in the U.S.
Economy, 1929 1982
Sources of Growth in the United States, 1929 1982
PERCENT OF GROWTH ATTRIBUTABLE TO EACH SOURCE

1929 1982 1929 1948 1948 1973 1973 1979

Increases in inputs 53 49 45 94
Labor 20 26 14 47
Capital 14 3 16 29
Education (human capital) 19 20 15 18

Increases in productivity 47 51 55 6
Advances in knowledge 31 30 39 8
Other factorsa 16 21 16 2

Annual growth rate 2.8 2.4 3.6 2.6

in real national
income
Economies of scale, weather, pollution abatement, worker safety and health, crime, labor disputes, and so forth.
a

Source: Edward Denison, Trends in American Economic Growth, 1929 1982 (Washington: Brookings Institution, 1985).

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Labor Productivity, 1952 2000

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Labor Productivity, 1952 2000

Some of the explanations for the slowdown

in productivity growth in the 1970s include:
a low rate of saving
increased environmental and government
regulations
lack of spending in R&D
high energy costs

However, many of these factors turned

around in the 1980s and 1990s yet
productivity growth remained low.
2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Economic Growth and Public Policy

Policy provisions to improve the quality of

education include the new Education
Individual Retirement Account that allows
savings to earn tax free returns as long as
the balance is used to pay for educational
expenses.
Policies to increase the saving rate
include individual retirement accounts that
accumulate earnings without paying
income tax.
2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Economic Growth and Public Policy

The amount of capital accumulation is

ultimately constrained by its rate of saving.
The tax system and the social security
system in the United States are biased
against saving.
Some public finance economists favor
shifting to a system of consumption
taxation rather than income taxation to
reduce the tax burden on saving.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 Economic Growth and Public Policy

Other public policies to stimulate

economic growth include:
policies to stimulate investment
policies to increase research and development
reduced regulations
industrial policy, or government involvement
in the allocation of capital across
manufacturing sectors.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 The Pro-Growth Argument

Advocates of growth believe growth is

progress.
New technologies and production
methods lead to new and better products.
Capital accumulation and new technology
improve the quality of life.
In 1995, real GDP per capita was more
than twice what it was in 1950. Since the
1950s, incomes have grown twice as fast
as prices.
2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 The Pro-Growth Argument

Advocates of growth believe growth is

progress.
Growth gives us more choices.
New technologies and production
methods lead to new and better products.
Capital accumulation and new technology
improve the quality of life.
Since the 1950s, incomes have grown
twice as fast as prices so we can buy that
much more.
2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 The Pro-Growth Argument

Growth saves the most valuable

commoditytime.
Growth also improves the quality of things
that yield satisfaction directly.
Growth produces jobs and higher incomes.
With higher incomes we can better afford
the sacrifices needed to help the poor.
When population growth is not
accompanied by growth in output,
unemployment and poverty increase.
2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
 The Anti-Growth Argument

Growth has negative effects on the quality

of life.
Growth encourages the creation of
artificial needs.
Growth means the rapid depletion of a
finite quantity of resources.
Growth requires an unfair income
distribution and propagates it.

2001 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair