March 10 Flashcards
short definition of economic growth
the SUSTAINED, long-run increases in the level of real GDP
3 aspects of economic growth
- real GDP per worker
- real per capita GDP
- real GDP
real per capita GDP
GDP divided by the population
focuses on economic wellbeing
real GDP per worker focuses on…
productivity
small differences in income growth rates make…
enormous differences in levels of income over a few decades
ie. income is 100 in year 0
^ at growth rate of 3% per year, it’ll be 134 in 10 years, 438 after 50 years, 1922 after 100 years
^ big differences in income levels between 2% and 3% growth rates
rule of 72
used to understand the CUMULATIVE EFFECTS of growth rates
for any variable that grows at an annual rate of x percent, that variable will DOUBLE in approx 72/x years
2 benefits of economic growth
- rising average living standards
- addressing poverty and income inequality
rising average living standards
(a benefit of economic growth)
- economic growth that RAISES AVERAGE INCOME tends to change the whole society’s consumption patterns, SHIFTING AWAY from TANGIBLE GOODS and going TOWARDS SERVICES
- economic growth provides higher incomes that often lead to DEMAND FOR CLEANER ENVIRONMENT
addressing poverty and income inequality
(a benefit of economic growth)
- in recent years, the majority of aggregate income growth in many countries (including Canada) has been ACCRUING to the TOP EARNERS in the income distribution
- while average per capita income has been rising, there has ALSO been a RISE IN INCOME INEQUALITY
- poverty and income inequality = importance challenges for public policy
2 costs of economic growth
- forgone consumption
- social costs
forgone consumption
(cost of economic growth)
economic growth, which promises more goods and services in the future, is achieved by CONSUMING FEWER GOODS TODAY
this sacrifice of current consumption is an important cost of growth
social costs
(cost of economic growth)
process of economic growth is disruptive for some businesses and workers
social costs come from workers’ skills becoming obsolete
the opportunity cost of economic growth
reduced current consumption
the benefit of economic growth
higher future consumption
4 major determinants of growth
- growth in the LABOUR FORCE
- growth in HUMAN CAPITAL
- growth in PHYSICAL CAPITAL
- technological improvement
different theories of economic growth emphasize different…
sources of growth
in the simplest short-run macro model, equilibrium level of real GDP equals…
desired consumption + desired investment
Y = C + I
Y - C = I
S = I
^ in the short-run, real GDP adjusts to determine equilibrium, in which desired saving equals desired investment
in the short run, real GDP does what to determine equilibrium?
real GDP ADJUSTS
until desired savings = desired investment
in the model’s long-run version, real GDP is equal to what?
Y* and the interest rate’s adjustments
Y* and the interest rate adjust to determine equilibrium
with real GDP equal to Y* in the long-run, DESIRED PRIVATE SAVINGS is what?
private saving: Y* - T - C
where T is taxes net of transfers
with real GDP equal to Y* in the long-run, DESIRED PUBLIC SAVINGS is what?
public saving: T - G
national saving in the long run
private saving + public saving
Y* - T - C + (T - G)
Y* - C - G
for a given level of real GDP in the long run (Y*), an increase in household consumption or government purchases implies…
a reduction in national saving
economy’s market for financial capital is made up of…
- supply curve for national saving
- investment demand curve
in the long run, what’s the condition that determines the equilibrium interest rate?
the condition that national savings equals desired investment
this determines the real interest rate
- excess supply of saving drives the real interest rate down
- excess demand for investment drives the real interest rate up
increase in the supply of national savings does what to the real interest rate?
reduces the real interest rate
encourages more investment
what does a higher rate of investment do?
leads to a higher growth rate of potential output
what changes the equilibrium real interest rate and the rate of growth of potential output?
changes in the:
- supply of national savings
- demand for investment
an increase in the demand for investment (I) does what to the real interest rate?
increases the real interest rate
encourages more saving by households
higher rates of saving (and investment) lead to…
a higher growth rate of potential output
what kind of relationship exists between investment and growth rates?
positive relationship
what does a closed-economy model assume pertaining to changes in Canada’s investment demand or supply of national savings?
predicts that these will lead to changes in Canada’s equilibrium interest rate
even if interest rates in other countries are held constant
(but in OPEN ECONOMIES, there’s lots of INTERNATIONAL TRADE in financial aassets)
the fact that in open economies, there’s lot of international financial trade, means that…
interest rates on similar assets in different countries tend to move together
ie. when interest rates on 10 year Cad gov bonds rise by 1% point, similar changes usually happen to the interest rates on 10 year US gov bonds (and also on 10 year German, Japanese, Australian gov bonds…)
the law of one price in a globalized financial market
two assumptions
- financial capital is HIGHLY MOBILE and can be FREELY TRADED internationally
- there’s a SINGLE TYPE of financial capital in the world
if Cad has excess supply for financial capital at the equilibrium world interest rate, the extra saving…
can be used to ACQUIRE FOREIGN ASSETS
Cad as a whole has CAPITAL OUTLOW because Canadian financial capital is flowing abroad to purchase those assets
capitol outflow occurs when..
a country has excess savings at the equilibrium world interest rate
means there’s financial capital flowing abroad to purchase those assets
capital inflow occurs when…
a country has a national savings deficit at the world interest rate
aggregate production function
GDP = F^T (L, K, H)
L = labour
K = physical capital
H = human capital
T = technologyi
aggregate production function: F^T notation indicates
indicates that the function relating L, K and H to GDP depends on the state of technology
K in the aggregate production function
physical capital
L in the aggregate production function
labour
H in the aggregate production function
human capital
T in the aggregate production function
T
2 key assumptions in the aggregate production function
- the aggregate production function displays DIMINISHING MARGINAL RETURNS when any one of the factors is increased on its own
- CONSTANT RETURNS TO SCALE when all factors are increased together
(for simplicity, we assume that human capital and physical capital can be combined into a single variable called capital, and that technology is held constant)
aggregate production function: with one input held constant, the other input has a declining…
average and marginal product
in neoclassical model with diminishing marginal returns, increases in population and fixed capital, what happens?
- increases in GDP
- but an eventual decline in material living standards
(LABOUR FORCE GROWTH scenario)
in neoclassical model, capital accumulation leads to improvements in material living standards BUT
but because of the law of diminishing returns
these improvements become SMALLER with EACH ADDITIONAL INCREMENT of capital
(PHYSICAL AND HUMANN CAPITAL ACCUMULATION scenario)
balanced growth with constant technology (neoclassical model)
- if capital and labour grow at the SAME RATE, GDP will increase
- in a model with constant returns to scale, such balanced growth won’t lead to increases in per capita output and therefore WON’T GENERATE IMPROVEMENTS IN MATERIAL LIVING STANDARDS
(BALANCED GROWTH with CONSTANT TECHNOLOGY scenario)
importance of technological change (neoclassical model)
technological change is assumed to be EXOGENOUS
new knowledge can contribute to growth of potential output (even without capital accumulation or labour force growth)
embodied technological change
technological improvements are contained in the new capital goods
the “Solow Residual”
by Robert Solow, MIT
his “growth accounting” method estimates technical change as the part of growth that’s unexplained by capital accumulation or labour-force growth
the “Solow Residual”
the name of Solow’s method
“growth accounting”
computer example: the Solow residual
firm that adds to its stock of capital by purchasing 2 new computers
- increases in the capital stock
- increases in the level of technology
Solow method would attribute ALL THE CHANGE to the change in capital stock - UNDERESTIMATES the true amount of technological change
alternative definition of the Solow residual
Solow residual shows the unexplained portion of growth after accounting for capital and labor
in practice, it’s used to estimate how much of a country’s economic growth can be attributed to improvements in technology, efficiency, or other factors not directly related to increases in labor or capital
should workers be scared of technological change?
nope!
as long as labour markets adjust to changes in demand and supply for labour, overall level of EMPLOYMENT will GROW IN LINE WITH POPULATION
^ independent of the rate of technological change
if overall technological progress leads to an increased demand for skilled workers, who will profit most?
those workers most able to adapt to changing economic conditions
(unlike those without requisite skills)
endogenous technological change
technological change is responsive to economic signals (PRICES and PROFITS)
it’s endogenous to the economic system!
how is technological growth achieved?
through costly, risky, innovative activity
that often occurs in response to economic signals (prices and profits)
4 things that achieve technological growth in response to economic signals (prices/profits)
- learning by doing
- knowledge transfer
- market structure and innovation
- shocks and innovation
neoclassical theories
often associated with the Solow-Swan model
framework that seeks to explain how economies grow over time
emphasizes the role of capital accumulation, labor growth, and technological progress in driving long-term economic growth
neoclassical theories of economic growth assume that investment in capital is subject to…
diminishing marginal returns
some research suggests the possibility of INCREASING RETURNS that remain for considerable periods of time
2 sources of increasing returns
a) market-development costs
b) economics of ideas
resource exhaustion
since WWII - rapid acceleration in consumption of resources (fossil fuels, basic minerals)
world’s current resources & capacity to cope with pollution/environmental degradation - insufficient to accomplish rise in global living standards with present technology
most economists agree that absolute limits to growth, based on assumptions of constant tech and fixed resources, aren’t relevant
how can further growth be achieved?
- further growth must be SUSTAINABLE growth
- sustainable growth should be based on KNOWLEDGE-DRIVEN TECHNOLOGICAL CHANGE
