Do Now.

1. Do Now. • Define: GDP, Real GDP, and real GDP per capita • Define productivity • In your opinion, are workers today more or less productive than workers 100 years ago? Why or why not? • Why are some countries more productive than others?

2. AP Macroeconomics MR. Graham Unit Seven Economic Growth and Productivity

3. Module 37: Long-run Economic Growth 3

4. India has a real GDP more than fifteen times as large as that of Denmark India’s population is about 200 times greater than that of Denmark India is relatively poor and Denmark is relatively rich Measuring Economic Growth

5. Economic Growth: Increase in per capita real GDP measured by its rate of change per year We focus on GDP because it measures total value of an economy’s production of final goods and services as well as the income earned in that economy in a given year. We use real GDP because we want to separate changes in the quantity of goods and services from the effects of a rising price level. We focus on real GDP per capitabecause we want to isolate the effect of changes in the population. Measuring Economic Growth

6. Measuring Economic Growth • Despite dramatic economic growth in India and China over the last 50 years, China has only just attained the standard of living that the United States enjoyed in 1908, while India is still poorer than the United States was in 1908.

7. A typical family in 1908 probably had purchasing power only 15% as large as purchasing power of a typical family in 2008. That’s around $8,000 in today’s dollars, representing a standard of living that we would now consider severe poverty. Measuring Economic Growth

8. In fact, today more than 50% of the world’s people live in countries with a lower standard of living than the United States had a century ago. Measuring Economic Growth

9. Measuring Economic Growth • Even though the U.S. is one of the world’s richest countries, our rate of economic growth in recent decades has been in the mid-range. • U.S. per capita real GDP has remained higher than other nations because we have been able to sustain growth over many decades.

10. The importance of growth rates Do we need to worry about small differences in the economic growth rate? A small difference in the rate of economic growth does not matter very much for next year or the year after, but it makes considerable difference for the more distant future due to compounding. Measuring Economic Growth

11. GDP in 50 years at various growth rates starting at $1 trillion 3% 4% 5% $4.38 trillion $7.11 trillion $11.5 trillion Measuring Economic Growth

12. Example: At an annual growth rate of 10%, per capita real GDP should double in about: Growth Rates • The Rule of 70 • the appropriate number of years required for per capital real GDP to double.

13. Sustained growth in real GDP per capita occurs only when the amount of output produced by the average worker increases steadily. The term labor productivity, or productivity for short, is used to refer to output per worker. For the economy as a whole, productivity—output per worker—is simply real GDP divided by the number of people working. Sources of Long-Run Growth

14. There are three main reasons why the average U.S. worker today produces far more than his or her counterpart a century ago: The modern worker has far more physical capital, such as tools and office space, to work with. The modern worker is much better educated and so possesses much more human capital. Modern firms have the advantage of a century’s accumulation of technical advancements reflecting a great deal of technological progress Explaining Growth in Productivity

15. Do Now. • Why are works more productive today than 100 years ago? • What are some things that made countries wealthy 100 years ago? What makes countries wealthy today? Are these things the same? • In your opinion, which generally leads to greater increases in real GDP: technology or investment spending?

16. Module 38: Productivity and Growth 16

17. Productivity is higher, other things equal, when workers are equipped with more physical capital, more human capital, better technology, or any combination of the three. To put numbers to these effects, economists make use of estimates of aggregate production function Shows how productivity (output per worker) depends on the quantities of physical capital per worker and human capital per worker as well as the state of technology. Accounting for Growth: The Aggregate Production Function

18. The function reflects a positive relationship (i.e. upward sloping curve) between the determinants of productivity and output. Accounting for Growth: The Aggregate Production Function

19. In analyzing historical economic growth, economists have discovered the relationship between physical capital and productivity exhibits diminishing returns, ceteris paribus. Diminishing Returns to Physical Capital

20. When the amount of human capital per worker and the state of technology are held fixed, each successive increase in the amount of physical capital per worker leads to a smaller increase in productivity. Ex.—farming with a tractor as opposed to without, farming with a more expensive tractor as opposed to a cheaper one Diminishing Returns to Physical Capital

21. In practice, all factors (physical capital, human capital, and technology advances) contributing to higher productivity rise during course of economic growth. To disentangle the effects of these factors, economists use the aggregate production function to estimate the contribution of each factor to economic growth. Accounting for Growth: The Aggregate Production Function

22. How do we disentangle the effects of each factor? Suppose the following are true: The amount of physical capital per worker grows 3% a year. According to estimates of the aggregate production function, each 1% rise in physical capital per worker raises output per worker by one-third of 1%, or .33%. In this case, we estimate that growing physical capital per worker is responsible for 1 percentage point (3% x .33) of productivity growth per year. A similar but more complex procedure is used to estimate the effects of growing human capital… Accounting for Growth: The Aggregate Production Function

23. Can we estimate the effects of technological progress? Yes—by estimating what is left over after the effects of physical/human capital have been taken into account. Accounting for Growth: The Aggregate Production Function

24. In this case, 50% of the annual 2% increase in productivity is due to higher total factor productivity (i.e. technological progress). Accounting for Growth: The Aggregate Production Function • Without any change in technology, output rises from $30,000 to $60,000 (1% per year according to the Rule of 70). • In reality, output rose from $30,000 to $120,000 (2% per year).

25. Accounting for Growth: The Aggregate Production Function • According to the Bureau of Labor Statistics, over the period from 1948 to 2008 American labor productivity rose 2.6% per year. • 46% of that rise is explained by increases in physical and human capital per worker; the rest is explained by technological progress.

26. An example of an aggregate production function was created by the Brookings Institution from a comparative study of Chinese and Indian growth: GDP per worker = T x (Physical capital per worker)0.4 x (Human capital per worker)0.6 Using this function, they tried to explain why China grew faster than India between 1978 and 2004. About half the difference, they found, was due to China’s higher levels of investment spending.. Other half was due to faster Chinese technological progress. (T represents an estimate level of technology) Accounting for Growth: The Aggregate Production Function

27. Other things equal, countries that are abundant in valuable natural resources, such as highly fertile land or rich mineral deposits, have higher real GDP per capita than less fortunate countries (i.e. Middle East). Historically, natural resources played a much more prominent role in determining productivity. In the modern world, natural resources are a much less important determinant of productivity than human or physical capital for the great majority of countries What About Natural Resources?

28. Understanding the Rise of China: Martin Jacques • http://www.ted.com/talks/martin_jacques_understanding_the_rise_of_china.html

29. Do Now. • http://www.criticalcommons.org/Members/fsustavros/clips/louis-ck-technology • http://www.criticalcommons.org/Members/AdrianFohr/clips/disappearing-gangs-of-new-york

30. Module 39: Growth Policy: Why Economic Growth Rates Differ 30

31. In 1820, according to estimates by the economic historian Angus Maddison, Mexico had somewhat higher real GDP per capita than Japan. Today, Japan has higher real GDP per capita than most European nations and Mexico is a poor country, though by no means among the poorest. The difference? Over the long run, real GDP per capita grew at 1.9% per year in Japan but at only 1.2% per year in Mexico. Why Growth Rates Differ

32. As one might expect, economies with rapid growth tend to be economies that add physical capital, increase their human capital, or experience rapid technological progress. Striking economic success stories, like Japan in the 1950s and 1960s or China today, tend to be countries that do all three: that rapidly add to their physical capital, upgrade their educational level, and make fast technological progress Capital, Technology, and Growth Differences

33. Adding to Physical Capital Occurs through high rates of investment spending. Must be paid for either out of savings from domestic households or by an inflow of foreign capital (i.e. savings from foreign households). The Role of Government Government subsidies to infrastructure (direct) Maintaining a well-functioning financial system Political stability and good governance Encouraging to Economic Growth

34. Adding to Human Capital The Role of Government Government subsidies to education Encouraging to Economic Growth

35. Technological Progress Scientific advances gained through private spending on R&D make new technologies possible. Scientific knowledge must be translated into useful products/processes and applied. The Role of Government Government subsidies to R&D Protection of property rights Encouraging to Economic Growth

36. Success, Disappointment, and Failure

37. East Asia’s Miracle Very high savings rates have increased the amount of physical capital per worker Very good basic education has improved human capital Substantial technological progress Rapid growth largely due to the relatively low “starting point”. Convergence hypothesis—international differences in real GDP tend to narrow over time Diminishing returns of physical and human capital; Replication of production methods (i.e. technology). Success, Disappointment, and Failure

38. Latin America’s Disappointment Abundant natural resources, but… Relatively low rate of savings and investment spending Education has been underemphasized Governments have tried to “open” their economies, but result has not yet been productive. Success, Disappointment, and Failure

39. Africa’s Troubles Real GDP per capita in sub-Saharan Africa (about 780 million people) fell 13% from 1980-1994. Political instability since 1975 has killed millions of people and made productive investment spending impossible. Property rights are lacking Unfavorable geographic conditions (hot, landlocked, poor soil, tropical diseases). Opening of economy has improved their situation. Success, Disappointment, and Failure

40. Natural Resources and Growth, Revisited Limited supplies of nonrenewable resources (i.e. oil and natural gas) may be a limitation of growth. How large are the supplies of key natural resources? How effective will technology be at finding alternatives to natural resources? Can long-run economic growth continue in the face of resource scarcity? Is World Growth Sustainable?

41. Economists maintain that resource scarcity leads to higher resource prices, which, in turn, provides strong incentives to conserve the scarce resource and to find alternatives. Is World Growth Sustainable?

42. The much greater problem associated with growth are environmental issues. Is World Growth Sustainable?

43. Sustainable growth, then, must include: Policy to encourage productivity increases; Policy to seek and employ alternatives to scarce resources; Policy to protect the environment. Is World Growth Sustainable?

44. “Costs” of Economic Growth

45. TED • http://www.ted.com/talks/niall_ferguson_the_6_killer_apps_of_prosperity

46. Do Now: Watch these videos Questions How does technology impact economic growth? Will technology ever become a negative? Why or why not? What three technologies are contributing most to economic growth in your opinion? • http://www.criticalcommons.org/Members/MCIMR/clips/clip-from-spaceballs • http://www.criticalcommons.org/Members/JLipshin/clips/THE_MATRIX_glitches2.mp4

47. Module 40: Economic Growth in Macroeconomic Models 47

48. As we have seen throughout this section, long-run economic growth depends almost entirely on rising productivity. Good macroeconomic policy strives to foster increases in productivity, which in turn leads to long-run economic growth. In this module, we will learn how to evaluate the effects of long-run growth policies using the production possibilities curve and the aggregate demand and supply model. Long-Run Economic Growth

49. Long-Run Economic Growth and the Production Possibilities Curve

50. Long-Run Economic Growth and the Production Possibilities Curve • Point A—economy cannot survive without consumer goods • Points towards A create more production possibilities • Point D—services will be provided for citizens but the value of its physical capital will depreciate over time if Kyland continues to produce at this point over time. (curve would eventually shift inward over time) • Points B and C are acceptable, depending on values of the society