Chapter 7 Flashcards
Production and growth
The average person in a rich country, such as Canada, the United States, or Germany, has an income more than ten times as high as the average person in a poor country.
In Canada over the past century, average income as measured by real GDP per person has grown by about 2 percent per year.
This rate of growth implies that average income doubles every 35 years.
Average income today is about eight times as high as average income a century ago.
Production and growth Part 2
Growth rates vary substantially from country to country.
From 1990 to 2017:
GDP per person in China grew at a rate of 9 percent per year = tenfold increase in average income
Income per person in Zimbabwe fell by a total of 27 percent.
ECONOMIC GROWTH AROUND THE WORLD
Data on real GDP per person show that living standards vary widely from country to country.
Income per person in Canada is about:
3 times higher than that of China
6.5 times higher than that of India
From 1900-2017: Highest to Lowest Growth Rate Per Year
China: 2.64%
Japan: 2.60%
Brazil: 2.50%
…
Lowest 3:
Pakistan: 1.65%
Bangladesh: 1.48%
UK: 1.43%
PRODUCTIVITY: ITS ROLE AND DETERMINANTS
Explaining the large variation in living standards around the world is very easy.
PRODUCTIVITY: the quantity of goods and services produced from each hour of a worker’s time.
A country’s standard of living depends on its ability to produce goods and services.
PRODUCTIVITY: ITS ROLE AND DETERMINANTS
Why Productivity Is So Important
- Productivity is the key determinant of living standards.
- Growth in productivity is the key determinant of growth in living standards.
- For a country to enjoy a high standard of living, it must produce a large quantity of goods and services.
PRODUCTIVITY: ITS ROLE AND DETERMINANTS PT2
How Productivity Is Determined
Determinants of productivity
* Physical capital per worker
* Human capital per worker
* Natural resources per worker
* Technological knowledge
PRODUCTIVITY: ITS ROLE AND DETERMINANTS PT3
How Productivity Is Determined: More in depth
PHYSICAL CAPITAL: the stock of equipment and structures that are used to produce goods and services
HUMAN CAPITAL: the knowledge and skills that workers acquire through education, training, and experience
NATURAL RESOURCES: the inputs into the production of goods and services that are produced by nature, such as land, rivers, and mineral deposits
TECHNOLOGICAL KNOWLEDGE: society’s understanding of the best ways to produce goods and services
To use a relevant metaphor, tech knowledge is the quality of society’s textbooks, whereas human capital is the amount of time that the population has devoted to reading them.
ECONOMIC GROWTH AND PUBLIC POLICY
- The importance of saving and investment
- Diminishing returns and the catch-up effect
- Investment from abroad
- Education
- Health and nutrition
- Property rights and political stability
- Free trade
- Research and development
- Population growth
ECONOMIC GROWTH AND PUBLIC POLICY PT2
The Importance of Saving, Investment, and Stable Financial Markets:
- Because resources are scarce, devoting more resources to producing capital requires devoting fewer resources to producing goods and services for current consumption.
- Accumulating capital involves a tradeoff.
- When governments encourage saving and investment, they also encourage growth and in the long run this raises the standard of living.
- A well-functioning and carefully regulated financial market is a critical ingredient in the recipe for economic growth.
ECONOMIC GROWTH AND PUBLIC POLICY PT3
Diminishing Returns and the Catch-up Effect
- Policies that raise the saving rate mean that fewer resources are needed to make consumption goods and more resources are now available to make capital goods.
- The capital stock increases, which raises productivity thus leading to a higher rate of growth of GDP.
- The benefits from additional capital become smaller over time, so growth slows down.
ECONOMIC GROWTH AND PUBLIC POLICY PT4
Diminishing Returns and the Catch-up Effect (cont’d):
In the long run, the higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables. This phenomenon is known as diminishing returns.
- DIMINISHING RETURNS: the benefit from an extra unit of an input declines as the quantity of the input increases
The diminishing returns to capital has another important implication: it is easier for a country to grow if it starts out relatively poor.
- CATCH-UP EFFECT: countries that start off poor tend to grow more rapidly than countries that start off rich
ECONOMIC GROWTH AND PUBLIC POLICY: Investment from Abroad
Investment by foreigners can also lead to new capital.
- FOREIGN DIRECT INVESTMENT: a capital investment that is owned and operated by a foreign entity
- FOREIGN PORTFOLIO INVESTMENT: an investment that is financed with foreign money but operated by domestic residents
Foreign investment in Canada raises the income of Canadians (this is captured in GNP) by less than it raises production in Canada (this is captured by GDP).
ECONOMIC GROWTH AND PUBLIC POLICY: Education
Investment in human capital (education) is at least as important as investment in physical capital for long-run economic success.
It is well known that more education leads to higher wages and salaries.
One way government policy can improve the standard of living is to provide good schools.
Human capital is also important for economic growth because it conveys positive externalities.
- EXTERNALITIES: the effect of one person’s actions on the well-being of a bystander.
Some poor countries face a brain drain.
- BRAIN DRAIN: the immigration of many of the most highly educated workers to rich countries, where they can enjoy a higher standard of living.
For example, an educated person might generate a new idea that enters society’s pool of knowledge and therefore society can benefit from it.
ECONOMIC GROWTH AND PUBLIC POLICY: Health and Nutrition
Healthier workers are more productive.
The causal link between health and wealth runs in both directions.
- Poor countries are poor in part because the populations are not healthy. Their populations are not healthy in part because they are poor.
It is a vicious cycle.
This opens the possibility of a virtuous cycle.
- Policies that lead to more rapid economic growth would naturally improve health outcomes.
In turn, this would further promote economic growth.
ECONOMIC GROWTH AND PUBLIC POLICY: Property Rights and Political Stability
In a free-market economy, it is the invisible hand that brings supply and demand into balance in the many thousands of markets.
For the price system to work, property rights must be respected.
PROPERTY RIGHTS: the ability of people to exercise authority over the resources they own
Political instability is a threat to property rights.
Countries with an efficient court system, honest government officials, and a stable constitution will typically enjoy a higher standard of living.
ECONOMIC GROWTH AND PUBLIC POLICY: Free Trade
Most economists today will say that a poor country is better off pursuing outward-oriented (as opposed to inward-oriented) policies that integrate these countries into the world economy.
Countries that eliminate trade restrictions often experience the same kind of economic growth that would occur after a major technological advance.
Trade volume is determined not only by government policy but also by geography.
Many countries in Africa are landlocked and therefore do not have access to the sea, which explains why the African continent is so poor.
ECONOMIC GROWTH AND PUBLIC POLICY: Research and Development
One of the major reasons that living standards are so much higher today than they were a century ago is because state-of-the-art technological knowledge has progressed so much.
Even if most R&D is conducted in the private sector, there is a public interest in promoting such efforts.
Knowledge is a public good.
Governments have a vested interest in promoting R&D.
ECONOMIC GROWTH AND PUBLIC POLICY: Research and Development Pt 2
Research and Development (cont’d)
Over the years, the Canadian government has:
- Funded research in CANDU nuclear reactors.
- Offered research grants from NSERC and SSHRC.
- Offered tax breaks to firms that engage in R&D.
- Managed the patent system.
NSERC: National Sciences and Engineering Research Council of Canada
SSHRC: Social Sciences and Humanities Research Council of Canada
ECONOMIC GROWTH AND PUBLIC POLICY: Population Growth
A large population means a larger total output of goods and services.
However, it need not mean a higher standard of living for a typical citizen.
Beyond these obvious effects of population size, population growth interacts with the other factors of production in ways that are more subtle and open to debate.
ECONOMIC GROWTH AND PUBLIC POLICY: Population Growth Pt 2
Stretching natural resources
* A large population means a larger workforce.
* A large population means more consumers.
A large population need not mean a higher standard of living.
Thomas Robert Malthus (1766–1834) argued that an ever-increasing population would continually strain society’s ability to provide for itself.
* Mankind was doomed to forever live in poverty.
ECONOMIC GROWTH AND PUBLIC POLICY: Population Growth Pt 3
Diluting capital stock
- According to this theory, high population growth reduces GDP per worker because rapid growth in the number of workers forces the capital stock to be spread more thinly.
- A smaller quantity of capital per worker leads to lower productivity and lower GDP per worker.
Some believe that reducing the rate of population growth would help poor countries raise their standards of living:
- By regulating the number of children (e.g., China).
- By policies that foster equal treatment of women.
ECONOMIC GROWTH AND PUBLIC POLICY: Population Growth Pt 4
Promoting technological progress
- Some economists believe that population growth has been an engine of technological progress and economic prosperity.
- More people means more scientists, more inventors, and more engineers
CONCLUSION: THE IMPORTANCE OF LONG-RUN GROWTH
A country’s standard of living depends on its ability to produce goods and services.
Policymakers who want to encourage growth in standards of living must aim to increase their nations’ productive ability.
Economists differ in their views of the role of government in promoting economic growth.
At the very least, government can lend support to the invisible hand by maintaining property rights and political stability.
More controversial is whether government should target and subsidize specific industries that might be especially important for technological progress.
Figure 7.1: Illustrating the Production Function
Curve from bottom left to top right:
The curve becomes flatter as the amount of capital increases, because of diminishing returns to capital.
So at the bottom left: When the economy has lower level of capital, an extra unit of capital leads to a large increase in output
Ath the top right: When the economy has higher level of capital, an extra unit of capital leads to a smaller increase in output
