Economic growth

Question 1

Which economy is the largest?

Answer 1

• Based on GDP (current price), in 2016 the US’ GDP is about 1.67 times China’s.

but

• Based on GDP (PPP, current price), in 2016, China’s GDP is 115% the US’ GDP.

Question 2

Annual growth rate:

Definitiona and formula

Answer 2

• This is the formula to calculate the annual growth rate between two consecutive years only, (e.g. old year = 1992 and new year = 1993; old year = 2007 and new year = 2008).
• It does not apply to the case of non- consecutive years, (e.g. old year = 1992 and new year = 1997).

Question 3

The rule of 70:

Answer 3

= Number of years to double

• This is only an approximation.
• The estimated number of year is closer the actual figure if the annual growth rate is small (e.g. a few percent).

Question 4

Growth:

Answer 4

• When economists talk about growth, they mostly refer to the long-run movement (i.e. over a long period of time) of real GDP per capita.
• The growth of real GDP per capita has a central role in economics because it is the main (though imperfect) indicator of the standard of living.
• It is not useful to talk about growth of nominal GDP per capita because it mixes up the growth in real output and the growth in output price.

Question 5

Note about economic models:

Answer 5

• A model can only explain the phenomena it is designed to explain.
• No model can explain everything!
• A ‘good model’ is one that is simple yet can explain a lot of phenomena.

Question 6

Noclassical Growth Model:

Answer 6

• The Neoclassical growth model describes the supply side mechanism of long-run growth.
• It explains the limitations of capital accumulation and labour expansion for long-term growth.
• It also highlights the importance of technological progress for long-term growth.
• But it does not explain what brings about technology progress.

Question 7

Production Function:

Answer 7

Y = f(L, K, Te)

• L: labour input
• K: (physical) capital input
• Te: technology
• anything that raises the amount of output that can be produced with a given amount of labour and capital input.
• also calls multifactor productivity or total factor productivity

Question 8

Labour:

Answer 8

• The labour input “L” is measured in hour-worked, not the number of workers.
• Labour input = total no. of hours worked = no. of workers * no. of hours worked per worker
  
  • E.g. one person working 8 hours is equivalent to two persons working 4 hours each.
  • That is why the textbook uses the terms “output per hour worked” and “capital per hour worked”.

Question 9

Capital:

Answer 9

• Capital: manufacturing goods and infrastructure that are used to produce other G&S.
  
  • Examples: computers, robots, machines, vehicles, buildings, road, seaports, and airports.
• In economics, unless specified otherwise, “capital” typically means “physical capital” as in contrast to “financial capital” or “human capital”.

Question 10

Labour productivity:

Answer 10

• For the standing of living to improve, each person has to be able to produce more on average, i.e. there has to be an increase in output per labour.
• Output per labour = labour productivity.
• In the simplest version of Neoclassical model, labour productivity increases if there is
  
  • More physical capital
  • Technological progress

Question 11

Diminishing returns to capital input:

Answer 11

For given labour input and technology (i.e. they remain constant), there are diminishing returns to capital input, because adding more capital will reduce the amount of labour that each unit of capital can work with.

Question 12

Diminishing returns to labour input:

Answer 12

For given capital input and technology, there are diminishing returns to labour input, because adding more labour will reduce the amount of capital that each labour can work with.

Question 13

Technology & Diminishing returns:

Answer 13

• Technology is the only input that is not subject to diminishing returns and therefore the only source of sustainable growth in the long run.
• Because technology is non-rivalous: one person’s uses of a technology does not reduce the amount of technology uses by others.

Question 14

Technological Progress:

Answer 14

• Technological progress = firms produce more output with the same amount of inputs.
• Technology determines how effectively labour and capital are used in the production.

Examples of sources of technological progress

• better machinery and equipment
• better trained or educated workers
• better organization and management methods

Question 15

Side talk: fast internet spurs in Africa:

Answer 15

• New research shows that access to the fast internet in Africa via submarine cables has a large positive effect on employment.
• It shifts employment out of low-productivity occupations, such as small-scale farming, into higher productivity jobs, such as professional, clerical, and service jobs within a number of sectors, including retail, finance and manufacturing.
• It also positively affects business creation, productivity, export, income and wealth.

Question 16

Human capital =

Answer 16

Accumulated knowledge and skills that workers acquired from education and training or their life experience.

Question 17

Human capital as technology?

Answer 17

• The HGLO textbook (p.148) treats “increases in human capital” as the main source of technological change.
• Typically, economists consider “increases in human capital” as a distinct source of growth and do not categorize it as a kind of technological change.
• It is a matter of labeling. The textbook’s discussion of the effect of “increases in human capital” on growth remains correct.

Question 18

Side-talk: Assembly Line as technology

Answer 18

• Henry Ford (1863-1947) invented the assembly line technique of mass production.
• Before that, cars remained stationary on the factory floor, and workers needed to move around the factory to perform various tasks.
• With the assembly line, workers stayed on the same spot and performed the same task many times a day.
• It increased labour productivity dramatically but made the job very boring.
• To retain the workers, Ford paid them $5 per day, more than 17 times of what other manufacturers paid ($0.29)! This is an example of efficiency wage (see Topic 3 Unemployment)

Question 19

What affects growth?

Answer 19

Any thing that affects (1) the accumulation of physical capital per labour, (2) technological progress will affect output per labour and therefore (income) growth.

Question 20

Side-talk: Industrial Revolution

Answer 20

• Some argued that the institutional reform in Britain that shifted the power from the monarch to the Parliament and court formed the foundation for the Industrial Revolution.
• This power shift led to protection of private property right and wealth, and to eliminate arbitrary tax hikes.
• As a result, entrepreneurs had the incentives to invest in factory machines, railway, and many other manufacturing products.

Question 21

Intellectual property right:

Answer 21

• Without sufficient protection of intellectual property right, individuals or firms will not be willing to invest in research and innovation.
• A government can protect intellectual property right using patent (for manufactured products) and copyright (for books, movies, music, and software) laws.

Question 22

Economic openness:

Answer 22

• Trade: Domestic firms can import better equipment and materials.
• Foreign Direct Investment (FDI): Foreign firms can bring in funds and new technology.
• Foreign Portfolio Investment (FPI): Foreign firms can bring in funds.
• Trade and FDI also increase competition, forcing domestic firms to endeavor to become more efficient to survive.

Question 23

Economic openness world example: Korea vs Korea

Answer 23

• When South and North Korea were separated in 1945 after WWII, the two countries were equally poor.
• The two took very different approaches to economic management: North Korea pursued a “self-reliance” (i.e. close-door) policy, and South Korea opened up to international trade and investment.
• Today GDP per capita is over 40 times larger in the South than in the North.
• South Korean men are 3-8cm (1.2-3.1in) taller than their North Korean cousins, who were stunted by famine and malnutrition.

Question 24

Financial Markets:

Answer 24

• On the one hand, there are no advanced economies that do not have a well- developed financial market.
• On the other hand, as demonstrated by the Global Financial Crisis, when the financial market is not functioning properly, the consequence can be devastating.

Question 25

Saving & investment in GDP:

Answer 25

• In a closed economy, domestic investment has to be financed by domestic savings, i.e. S = I.
• What makes S = I hold is the real interest rate (r).
• If S ≠ I, then r will adjust till S = I.
• The relationship between S, I and r can be indirectly described by the loanable fund market model.

Question 26

The market for Loanable Funds:

Answer 26

• The supply of loanable funds is determined by the willingness of households to save and the extent of government saving or dissaving.
• The demand for loanable funds is determined by the willingness of firms to borrow to invest in new projects and of households to borrow to invest in new houses.
• Some may also borrow to fund consumption.

Question 27

S & I in open economies:

Answer 27

• In an open economy, domestic investment does not have to be equal to domestic savings, it can be financed by foreign capital.
• Likewise, domestic savings can be used to finance foreign investment.
• For instance, Australia has been a net receiver of foreign investment for decades.
• Foreign direct investment (FDI) could also be a source of better technology in some cases.