Chapter 9: Long-Run Economic Growth

Question 1

What is the Rule of 70?

Answer 1

A formula used to determine how long it takes a country’s real GDP per capita, or any other variable that grows slowly over time, to double. Note that the Rule of 70 can only be applied to a positive growth rate

Question 2

What is the formula for calculating the Rule of 70?

Answer 2

Number of years for variable to double = 70/Annual growth rate of variable

Question 3

What is long-run economic growth?

Answer 3

A sustained increase in output per capita

Question 4

What is the relationship between household income growth and growth in real GDP per capita?

Answer 4

They grow, typically, in proportion to one another (i.e., 1% of growth in real GDP per capita = 1% growth in household income)

Question 5

How much of the world live in countries with a lower standard of living than Canada a century ago?

Answer 5

25%

Question 6

What is the difference in change in level and rate of change re: long-run economic growth?

Answer 6

Level = $ amount of growth, rate = % amount of growth

Question 7

How is long-run economic growth measured?

Answer 7

Using real GDP per capita

Question 8

How much has real GDP increased in Canada since 1900?

Answer 8

Almost ninefold

Question 9

Why do economists use real GDP per capita to measure economic progress rather than some other measure, such as nominal GDP per capita or real GDP?

Answer 9

Nominal GDP per capita does not account for changes in price levels and may artificially inflate economic growth. Real GDP accounts for price changes but does not account for changes in population levels and may artificially inflate economic growth because if GDP only rises in tandem with rises in the population, real economic growth has not actually occurred. Therefore, real GDP per capita isolates both quantities of production and changes in the population and is a more accurate reflection of economic progress than nominal GDP per capita or real GDP

Question 10

Although China and India currently have growth rates much higher than Canadian growth rate, the typical Chinese or Indian household is far poorer than the typical Canadian household. Explain why.

Answer 10

High growth rates in real GDP only reflects standards of living increases when comparing a country to its own past. The average Chinese or Indian household is living on a real GDP per capita that is significantly lower than Canada’s and is closer to the standards of living in Canada in 1900. Changes in real GDP per capita growth rates do not equate to changes in the level of real GDP per capita. Indian and Chinese real GDP per capita have not yet caught up with GDP per capita in Canada

Question 11

What is the most important variable in long-run economic growth?

Answer 11

Rising (labour) productivity

Question 12

What is labour productivity (aka productivity, aka Average Productivity of Labour (AP1))?

Answer 12

Output per worker, sometimes output per hour

Question 13

What is the formula for productivity (aka output per worker)?

Answer 13

Real GDP/Number of people working

Question 14

In the long run, what is the relationship between population growth and employment growth?

Answer 14

They typically grow close to one another (i.e., 1.7% increase in population = 2.1% increase in employment)

Question 15

What is the difference between real GDP growth and real GDP per capita growth?

Answer 15

Real GDP can grow due to changes in population size. Real GDP per capita can only grow when output per worker increases, as it has accounted for population changes

Question 16

What are the 3 main factors that explain growth in productivity?

Answer 16

Physical capital, human capital, and technological progress

Question 17

What is physical capital?

Answer 17

Human-made, manufactured resources such as buildings or machines

Question 18

What is human capital?

Answer 18

Improvements in labour created by the education and knowledge of the workforce

Question 19

What is technological progress?

Answer 19

An advance in the technical means of production of goods and services

Question 20

What is the aggregate production function (aka the Cobb-Douglas production function) (definition)?

Answer 20

A relationship that shows how the aggregate real quantity of output is produced using the available factors of production (the inputs: labour, physical capital, and human capital) and technology (A) and the function (F…)

Question 21

What is the aggregate production function (aka the Cobb-Douglas production function) (formula)?

Answer 21

Y (GDP) = A (total factor productivity) * F(K (amount of physical capital used), L (amount of labour used), H (amount of human capital used))

Question 22

What is total factor productivity?

Answer 22

Represented as A in aggregate production function. Helps account for output that is not the result of the productive inputs. It captures all inputs and technological features left out of the aggregate production function.

Question 23

If total factor productivity and aggregate real output rise, and all else stays the same, what can this growth be attributed to?

Answer 23

Improvements in technology

Question 24

What is the positive marginal productivity of physical capital (MPk)?

Answer 24

The amount by which productivity is increased as a result of a small increase in physical capital used

Question 25

What is the per worker production function (definition)?

Answer 25

Function that shows how productivity (real GDP per worker) depends on the quantities of physical capital per worker, human capital per worker, and the state of technology

Question 26

What is the per worker production function (formula)?

Answer 26

Y/L (real output (GDP) per worker) = A (total factor productivity) * f(K/L (real physical capital per worker), H/L (human capital per worker))

Question 27

What does the per worker production function allow?

Answer 27

It allows economists to disentangle the effects of each of the three factors on overall production

Question 28

What is the per worker production function developed by Shen, Wang, and Whalley in a 2015 study?

Answer 28

GDP per worker = A * Physical capital per worker^1/3 * Human capital per worker^2/3

Question 29

What are diminishing returns to physical capital?

Answer 29

A per worker production function that holds the amount of human capital per worker and the state of technology fixed; each successive increase in the amount of physical capital per worker leads to a smaller increase in productivity

Question 30

What is the diminishing marginal propensity of (physical capital) (aka dim MPk)?

Answer 30

The same as diminishing returns of physical capital: A per worker production function that holds the amount of human capital per worker and the state of technology fixed; each successive increase in the amount of physical capital per worker leads to a smaller increase in productivity

Question 31

Why are there diminishing returns on physical capital?

Answer 31

Think of a farmer. A little bit of equipment makes a big difference: a worker with a tractor can do much more than a worker without one. However, a worker with a $40,000 tractor will not be double as productive as a worker with a $20,000 tractor, though they will still be more productive. There’s a huge difference between no tractor and a tractor, vs. an inexpensive tractor and an expensive tractor

Question 32

What kind of phenomenon is diminishing returns on physical capital?

Answer 32

An “other things equal” phenomenon, where technology and human capital are fixed

Question 33

What is growth accounting?

Answer 33

Accounting that estimates the contributions of each of the major factors (physical capital, human capital, technological progress) in the aggregate production function

Question 34

According to the per worker production function, how much does increase in physical capital increase output per worker?

Answer 34

1% increase in physical capital = 0.33% increase in output per worker

Question 35

How do we estimate the effects of technological progress on economic growth?

Answer 35

By taking what is left over after physical and human capital have been accounted for

Question 36

What factor challenged Thomas Malthus conclusion from his 1798 book, An Essay on the Principle of Population?

Answer 36

Malthus theorized that as population grew, the amount of land per worker would decline. This would cause productivity to fall. He stated that improvements in technology and physical capital would only lead to temporary increases in productivity because they would always be offset by the pressure of rising populations and more workers on the supply of land. It hasn’t turned out this way due to other, positive factors - technological advances, increases in physical and human capital, and exploiting land in the “New World”.

Question 37

What is the productivity paradox?

Answer 37

The disconnect between what looks like rapid technological progress (i.e, smartphones) and actual productivity (i.e., precut cardboard boxes)

Question 38

How do natural resources factor into productivity determinants?

Answer 38

Natural resources are less important today than physical and human capital as sources of productivity growth in most economies

Question 39

Predict the effect of each of the following events on the growth rate of productivity.

1) The amounts of physical and human capital per worker are unchanged, but there is significant technological progress.

2) The amount of physical capital per worker grows at a steady pace, but the level of human capital per worker and technology are unchanged.

Answer 39

1. The growth rate of productivity would increase.
2. The growth rate of productivity would increase, but then would see diminishing returns on physical capital and stagnate.

Question 40

Multinomics, Inc. is a large company with many offices around the country. It has just adopted a new computer system that will affect virtually every function performed within the company. Why might a period of time pass before employees’ productivity is improved by the new computer system? Why might there be a temporary decrease in employees’ productivity?

Answer 40

It will take some time for employees to adjust to the new computer system and learn how it functions. This may temporarily decrease employee productivity, as they may work slower while adapting to a new system

Question 41

What are some reasons for differences in countries’ economic growth rates?

Answer 41

Some countries increase their stock of physical capital more rapidly than others, through high rates of investment spending, as well as differences in education levels and R&D levels

Question 42

Where do funds for high investment spending come from?

Answer 42

Savings

Question 43

What is research & development (R&D)?

Answer 43

Spending to create new technologies and prepare them for practical use. It largely drives technological progress

Question 44

What are the six channels through which government policies can impact long-run economic growth?

Answer 44

1. Government subsidies to infrastructure
2. Government subsidies to education
3. Government subsidies to R&D
4. Maintaining a well-functioning financial system
5. Protection of property rights
6. Political stability and good governance

Question 45

What is infrastructure?

Answer 45

Physical capital, such as roads, power lines, ports, information networks, etc. that provides the foundation for economic activity

Question 46

Explain why government subsidies to infrastructure can impact long-run economic growth?

Answer 46

Poor infrastructure, such as a power grid that constantly fails, is a major obstacle to economic growth

Question 47

Explain why government subsidies to education can impact long-run economic growth?

Answer 47

Differences in the rate at which countries add to their human capital largely reflect government policy.

Question 48

Explain why government subsidies to R&D can impact long-run economic growth?

Answer 48

Governments fund and directly perform R&D, which can contribute to physical and human capital

Question 49

Explain why maintaining a well-functioning financial system can impact long-run economic growth?

Answer 49

A well-regulated and well-functioning financial system is important for economic growth because, in most countries, it is the principle way in which savings are channelled into investment spending

Question 50

Explain why protection of property rights can impact long-run economic growth?

Answer 50

Because no one would bother to spend the effort and resources required to innovate if someone else could appropriate that innovation and capture the rewards. So, for innovation to flourish, intellectual property rights must receive protection

Question 51

Explain why political stability and good governance can impact long-run economic growth?

Answer 51

Long-run economic growth in successful economies, like that of Canada, has been possible because there are good laws, institutions that enforce those laws, and a stable political system that maintains those institutions. Even when the government isn’t corrupt, excessive government intervention can be a brake on economic growth. If large parts of the economy are supported by wasteful government subsidies, protected from imports, subject to unnecessary monopolization, or otherwise insulated from competition, productivity tends to suffer because of a lack of incentives

Question 52

Explain the link between a country’s growth rate, its investment spending as a percent of GDP, and its domestic savings.

Answer 52

A country’s economic growth rate is heavily influenced by investment spending, as it can increase the amount of physical and human capital and technological innovation used. Investment spending is made possible through a country’s savings, both domestic and foreign, though domestic spending plays a large role in facilitating investment spending.

Question 53

Explain how the accumulation of human capital helps promote long-run economic growth. What should the government do to increase the buildup of human capital?

Answer 53

Increased human capital means that more of the population is more educated, which increases their skillsets and subsequent productivity. People can work better or faster with more knowledge of their work.
The government can invest in education subsidies, R&D subsidies, and the protection of property rights (particularly intellectual) to increase the buildup of human capital.

Question 54

Consider two countries, A and B. If country A’s academic biotechnology research has closer connections with private biotechnology companies than its counterparts, what effect might this have on the pace of creation and development of new drugs in country A versus country B?

Answer 54

Private companies are responsible for a large portion of increased physical capital. Subsequently, Country A may experience an increased pace of creation and development of new drugs when compared to Country B because the opportunities for research to be uptaken and applied may be easier to access as a result of their connections with private biotech companies. Closer links between academic institutions and private companies will lead to more R&D focused more on producing new drugs rather than pure research.

Question 55

What is the convergence hypothesis?

Answer 55

A principle of economic growth that holds that international differences in real GDP per capita tend to narrow over time because countries that start with lower real GDP per capita tend to have higher growth rates

Question 56

Why may some families see their income fall while overall income of the nation rises?

Answer 56

Unequitable distribution of wealth - the share of income going to families near the top of the income distribution (especially the 1%) has grown substantially in the past few decades

Question 57

What factors contributed to East Asia’s spectacular growth rate?

Answer 57

High savings and investment spending, an emphasis on education, and adoption of technological advances from other countries

Question 58

What factors contributed to Latin America’s slow growth rates?

Answer 58

Poor education, political instability, and irresponsible government policies

Question 59

What factors contributed to sub-Sahara Africa’s failure of growth?

Answer 59

Severe political instability, war, and poor infrastructure - particularly affecting public health. But economic performance has been improving in recent years

Question 60

Some economists think the high rates of growth of productivity achieved by many Asian economies cannot be sustained. Why might they be right? What would have to happen for them to be wrong?

Answer 60

The convergence hypothesis articulates that differences in GDP per capita between countries may be reducing because poorer countries experience higher economic growth rates due to accommodating technology already utilized in other jurisdictions and subsequent investment in physical/human capital. It can be inferred that they grow more slowly once a higher GDP per capita has been obtained. Therefore, once a certain amount of technology is implemented, and investments in physical/human capital are made, they may experience a plateau in economic growth.

Question 61

What is sustainable long-run economic growth?

Answer 61

Long-run growth that can continue in the face of limited supply of natural resources and with less negative impact on the environment

Question 62

What are “neo-Malthusian” theories?

Answer 62

Claims that economic growth will be severely limited by lack of resources

Question 63

Why have “neo-Malthusian” theories not been proven accurate so far?

Answer 63

Largely because of technological improvements that circumvent previous limits (i.e., investments in renewable energy). Resource scarcity leads to high resource prices. These high prices, in turn, provide strong incentives to conserve the scarce resource and find alternatives.

Question 64

Are economists typically more concerned about the limits to growth imposed by environmental degradation or those imposed by resource scarcity? Explain, noting the role of negative externalities (costs imposed by individuals or firms on others without the requirement to pay compensation), in your answer.

Answer 64

Environmental degradation, because resource scarcity forces economies to respond with changes in prices that promote conservation and the development of alternatives to previously utilized resources. Because environmental degradation imposes costs by individuals and firms onto others, without a requirement to pay compensation, effective government intervention is required to address it. Economists are more concerned with environmental degradation than resource scarcity because environmental degradation cannot be corrected by the market.

Question 65

What is the link between greenhouse gas emissions and growth? What is the expected effect on growth from emissions reduction? Why is international burden sharing of greenhouse gas emissions reduction a contentious problem?

Answer 65

Climate change is linked to long-run economic growth. The development of new factories and physical investment capital contributes to climate change and rising greenhouse gas emissions. Most advanced economies grew through industrialization and the burning of fossil fuels.
The expected effect on growth from emissions reduction is a modest reduction in growth. While there are definite economic costs to emissions reduction, those costs have been falling as a result of technological innovation in clean energy sources.
Climate change or other global environmental degredation issues are more difficult to solve than local environmental degredation. Local environmental degredation can be corrected with sufficient internal political will. But for global climate change, there is disagreement between who should pay the cost of shifting from fossil fuels to cleaner energy sources. More advanced countries have historically contributed to an increase in greenhouse gases, but emerging economies are now contributing to that increase. Advanced economies are reluctant to pay the cost only to have their efforts stymied by other emerging economies, and emerging economies are reluctant to pay for the past actions of more advanced economies. This resulted in the Paris Agreement.

Question 66

What is the Paris Agreement?

Answer 66

A commitment by 196 countries, signed in 2015, to reduce their greenhouse gas emissions in an effort to limit the rise in the earth’s temperature to no more than 2 degrees centigrade

Question 67

How can economies achieve long-run economic growth with environmental protection?

Answer 67

Economic growth tends to harm the environment unless actions are taken to protect it. Governments will need to use regulations and environmental standards, and institute policies that create market incentives to encourage individuals and firms to make the transition to clean energy sources. Finally, governments — both rich and poor — will need to continue to cooperate with one another

Question 68

How can local and global environmental degradation be addressed?

Answer 68

Local - political will and resources. Global - cooperation across many countries.

Question 69

How do you calculate average annual growth rate?

Answer 69

A * (1+g)t = B

Year 1 growth = A * (1+g1)
Year 2 growth = A * (1+g1)(1+g2)
T = 2
A(1+g)2 = A * (1+g1)(1+g2)
(1+g)2 = (1+g1)(1+g2)
(1+g) = ((1+g1)(1+g2))^1/2
g = ((1+g1)(1+g2))^1/2 - 1

Question 70

What is the employment-population ratio?

Answer 70

Total employment/total population

Question 71

What is the productivity formula for real GDP?

Answer 71

Real GDP = productivity (total output/total hour) * average hour (total hour/total employment) * employment population ratio (total employment/total population) * total population

Question 72

What is the productivity formula for real GDP/population?

Answer 72

Real GDP = productivity (total output/total hour) * average hour (total hour/total employment) * employment population ratio (total employment/total population)/total population

Question 73

What is the productivity formula for % change in real GDP per capita?

Answer 73

% change in real GDP per capita = % change in productivity + % change in average hour + % change in employment population ratio

Question 74

What is the Environmental Kuznet’s Curve?

Answer 74

The environmental Kuznets curve (EKC) is a hypothesized relationship between various indicators of environmental degradation and per capita income. In the early stages of economic growth, pollution emissions increase and environmental quality declines, but beyond some level of per capita income (which will vary for different indicators) the trend reverses, so that at high income levels, economic growth leads to environmental improvement.

Question 75

When was the 1900 US standard of living achieved in China and India?

Answer 75

2000 for China and 2016 for India

Question 76

Why is labour factor productivity the most important variable in long-run economic growth?

Answer 76

With growth in labour productivity, an economy is able to produce increasingly more goods and services for the same amount of work. And, because of this additional production, it is possible for a greater quantity of goods and services to ultimately be consumed for a given amount of work.

Question 77

What are Constant Returns to Scale?

Answer 77

A property of the production function that if the inputs are increased by some
proportion, outputs will increase by the same proportion

Question 78

What is the growth accounting formula?

Answer 78

%∆y = %∆A + (1/3) × %∆(K /L) + (2/3) × %∆(H/L)