Long Run Economic Growth Flashcards
Which metric is used to measure long run economic growth? Why do we use that metric?
-We use Real GDP per capita to measure long run economic growth.
-It’s better because it measures the value of final products and income. It ignores the effects of rising price level on output. And it isolates the effect of changes in population on output.
What is the rule of 70?
of years for a variable to double=70/annual growth rate of a variable
How do economists measure long run economic growth?
-APL=real GDP/#of workers
-In the long run, an increase in APL implies higher productivity.
-Don’t confuse APL with Real GDP per capita. They have a different denominator.
What are some factors that explain growth in productivity?
Growth in productivity occurs when real GDP increases.
1) Increase in physical capital
-Each worker has more capital to work with, so they can produce more. It’s harder to produce lots of stuff when you’re waiting for your colleague to finish with the machine.
2) Increase in human capital
-Refers to how educated or skilled the workforce is.
-Years of schooling is used as a proxy for human capital.
-Workers will know how to do things better and faster.
-That’s why education is subsidized.
3) Technological progress
-An improvement in production technology which allows us to produce more output with the same amount of inputs.
-R&D leads to technological progress.
What is the formula for aggregate production function?
Y=A*F(K, L, H)
where Y=aggregate real output (real GDP). A=total factor productivity (TFP). K=stock of physical capital. L=#of the labour used. H=stock of human capital.
-F helps to capture the relationship between K, L, H.
-A is isolated because holding all else constant, an increases, the GDP will increase. When total factor productivity increases things a lot.
What is the per worker production function?
-Take the Y=AF(K, L, H) labour productivity function. And then you divide that by L.
-Per worker production function is y=Af(K/L,H/L).
-Looking at historic economic growth, we notice a diminishing marginal product of phyiscal capital.
What is the physical capital per worker/capital-labour ratio?
K/L=k=(physical) capital per worker/capital-labour ratio
What is the human capital per worker ratio?
H/L-h=human capital per worker
How does the diminishing marginal product of physical capital show itself with the per worker production function?
-Holding A(total factor productivity) and H(stock of human capital) fixed, when K(stock of physical capital) goes up, y(overall production function) goes up, but at a decreasing rate.
Can you draw the physical capital and productivity graph?
What is held fixed? What do we look for?
The photo is on your phone.
K(stock of physical capital) and L(#of the labour used) is held fixed. We look at changes in A(total factor productivity) and H(changes in human capital).
What does the growth accounting equation tell us? What is it’s formula?
-The growth accounting formula can tell us how much technology benefits our production function. We learn this by rearranging the function so that technology is on one side of it.
-The photo of the formula is on my phone.
What are the two sources funds for investment can come from?
1) Domestic savings-savings done by households and government
2) Foreign savings-savings that come from foreigners (i.e. borrowing from abroad)
What are the four ways government policies can foster economic growth, and directly impact the labour productivity function?
1) Lower the cost of building infrastructure through the provision of subsidies. This improves K(stock of physical capital)
2) Make education less expensive by providing free or subsidzied education. So more people get educated and labour productivity goes up. This improves H(human capital)
3) Lower the cost of undertaking research and development(R&D) by providing subsidies (or tax credit) to R&D. The government tries to encourage Amazon to set up their second headquarter in Toronto. This improves A (total factor productivity)
4) Maintain a well-functioning financial system. Channels funds from savers to borrowers effectively. Increases investment, which increases K (stock of physical capital).
What are some things that the government can do to to increase long run economic growth? These things are not a part of the labour productivity function but still relevant.
1) Protection of property rights. Especially intellectual property rights, which incentivize innovation. Without intellectual property rights, nobody will have the incentive to innovate if others can easily copy their innovation and capture the rewards. That’s why Canada offers 20 year patents.
2) Political Stability and Good Governance. Even when a new government is elected, we feel stable: “ah we can carry on. It’s life as usual.”
What is the formula to calculate GDP growth rate in the future?
Future GDP=Current GDP*(1+annual growth rate expressed as a decimal)^number of years we are counting.
As physical capital per worker increases, what happens to marginal product of human capital per worker? What about marginal product of physical capital per worker?
-Marginal product of human capital per worker increases at a more rapid rate because their physical capital allows them to produce at a quicker rate.
-Marginal product of physical capital decreases because physical capital offers diminishing returns. It’s super helpful when you’re waiting to use a machine. But when you have more machines than people working, then that’s no good.
-Marginal product of physical capital per worker declines, because it has diminishing returns.
When human capital per worker increases, what happens to marginal product of physical capital per worker? What about marginal product of human capital per worker?
-Marginal product of physical capital per worker increases.
-Marginal product of human capital per worker decreases. There is also diminishing marginal product of human capital.
What is a constant returns to scale function?
However much you spend on input, you receive exactly that much in output.
In the growth accounting equation, what is alpha?
The fraction of income we give to the owner of physical capital.
What does the slope of the production function show?
-It shows the marginal product(diminishing).
Why may the government use the growth accounting equation?
-They have a target for output growth rate.
-This will affect their policy. Which in turn creates an incentive for firms to hold physical capital.
Why might growth rates suffer?
-Any factor that affects A, k, and h will affect y. And these include:
1) Savings and investment spending(affects K)
2) Education(affects H)
3) Spending on research and development (R&D). (affects A)
4) Government Policies(Affects A, K, and H)
5) Protection of Property Rights (Not just physical property rights also intellectual property right).
6) Political Stability and Good Governance
