Week 16 - Economic Growth Flashcards
Real GDP per person
A measure of the goods available to a typical person.
Can be a useful measure as it relates to a number of variables, such as life expectancy, infant health and literacy.
A country that produces more will be able to pay higher wages, meaning citizens can afford to buy more produced goods/ services.
Finding Real GDP per capita/person
Real GDP per person = output per worker * share of the population employed.
Output per person depends on how much each worker can produce and the percentage of the population that are working.
GDP per capita increases when output per worker or share of population employed increases.
Real GDP per capita formula
Y = real GDP
N = number of employed workers
POP = total population
Y/POP (real GDP per person) = Y/N * N/POP
Recent trends in living standards
Since 1700s many countries have had increasing living standards which can be associated to the adoption of capitalism.
In 19th and 20th century, there has been a large increase in the variety, quality and quantity of goods and services produced.
Capitalist revolution
New capitalist ideas reorganises the economy causing advances in technology and specialization in products and tasks raising the amount that could be produced in a day’s work.
Has also caused threats to natural environment and inequality.
Compound interest and GDP per capita
Paying interest on the original deposit and all previously accumulated interest.
Means that interest paid in year 1 earns interest in year 2.
With both compound interest and
GDP per capita, relatively small growth has a very large effect over a long period.
Average labour productivity
The amount of output produced per unit of labour input.
Determined by 6 factors: human capital, physical capital, land and other natural resources, technology, entrepreneurship and management, political and legal environment.
How human capital determines average labour productivity
Human capital comprises the talents, education, training, and skills of workers.
Higher human capital increases workers’ productivity and innovative skills and results in higher levels of output and economic prosperity.
How physical capital determines average labour productivity
Physical capital refers to machinery, equipment, buildings, infrastructure etc.
More and better physical capital increases worker productivity and raises quality.
Diminishing returns to capital: If the amount of labour and other inputs employed is held constant, then the greater the amount of capital already in use, the less an additional unit of capital adds to production.
How land and other natural resources determines average labour productivity
Inputs other than capital increase worker productivity, create jobs, generate revenue, and build a foundation for sustained economic growth.
Land can be very valuable e.g., for agricultural or tourism use.
Natural resources can be extracted and processed to provide jobs and income or drive innovation and technological advances.
Land or natural resources can be used to produce renewable energy - wind, solar and hydro power.
How technology determines average labour productivity
Advances in technology can mean that more output can be created from the same level of inputs by increasing efficiency.
Technology has made it easier for businesses to access global markets, both for selling goods and services and for sourcing inputs. Advantage of globalisation.
How entrepreneurship and management determines average labour productivity
Entrepreneurs create new economic enterprises and identify business opportunities.
They take risks, create new products or services, organize resources efficiently which is essential to a dynamic, healthy, growing economy.
They also create jobs, increase productivity, and generate wealth as well as increasing competition and driving improvements in efficiency, quality and customer service.
How political and legal environment determines average labour productivity
The political and legal environment can encourage people to be economically productive.
Political stability and predictability are critical for attracting investment and promoting economic growth.
Rule of law: a stable legal and institutional framework that ensures fairness, predictability, and enforcement of contracts, property rights, and economic policies. Countries with a strong rule of law generally experience higher economic growth, lower corruption, and greater income stability.
Solow growth model
A simple model used to explain economic growth.
It suggests a relationship between quantity of inputs in production process and the economy’s total output (Y).
Assume input consists of physical capital (K) and labour (N)
Physical capital: the machines and buildings used in the production of the economy’s GDP
Labour: the number of workers used in the production of goods and services.
Production function
Represents the relationship between total output (Y), physical capital (K) and labour (N).
Output is a function of labour and capital.
Y = F(K, N)
Constant returns to scale (CRS)
If the labour and capital inputs are both increased by equal proportions, then total output increases by the same proportion.
CRS production function: zY = F(zK, zN) where z is any positive number but assumed to be 1/N.
CRS production function simplifies to y=f(k)
Marginal product of capital (MPK)
MPK represents the amount of extra output the firm gets from an extra unit of capital, holding the amount of labour constant.
MPK = ΔY/ ΔK
MPK is assumed to be decreasing.
The gradient of the production function represents the MPK.
Investment and savings [Solow growth model]
Solow Model assumes that investment is financed by saving where saving is a constant fraction of income Y.
Assumes that all savings are invested.
Investment in physical capital (I)
Total savings (S)
Savings rate (s)
Income (Y)
I = S = sY
In long-run equilibrium, investment per worker will just be sufficient to keep the capital-labour ratio constant.
How much investment is required to keep the capital-labour ratio constant
Depends on depreciation rate and population growth.
Depreciation rate: part of the capital stock that wears out and becomes less productive each period.
If capital depreciates at rate d per period, then investment must be at least dk to keep the capital-labour ratio from falling.
Population growth: the growth of the labour force over time.
If the labour force grows at a constant rate n per period, then the economy will require an additional investment nk to keep the capital-labour ratio constant.
Need overall investment of (n+d)k to maintain constant capital-labour ratio.
E.g., with a depreciation rate of 3% and population growth of 2% per year, required investment per person employed is 5% to keep the capital-labour ratio constant.
Solow growth model in the long run
i = s*f(k)
if i < (d+n)k, k is decreasing over time.
if i = (d+n)k, economy is at a steady state where investment is just sufficient to maintain constant labour capital ratio.
if i > (d+n)k, k is increasing over time.
Equilibrium capital-labour ratio: the level of capital per worker where economy is in a steady state (i = (d+n)k).
Equilibrium capital-labour ratio determines the equilibrium value of average labour productivity.
Average labour productivity is found from the corresponding output per worker for the production function from the amount of capital per worker when the economy is steady.
Increase in the savings rate
Increase in the savings rate shifts the investment curve upwards, leading to higher investment.
Equilibrium capital-labour ratio and average labour productivity increase as well.
After savings rate increases, labour productivity and the growth rate of total output Y will exceed the rate of population growth n.
Once the economy reaches a new equilibrium, labour productivity stabilises and growth rate of total output Y will equal the rate of population growth n.
Solow model implications
There are two important conclusions in explaining economic growth:
- Average labour productivity depends on the amount of physical capital per head in the workforce - the more capital available to the workforce, the higher the level of both labour productivity and income per head of the population.
- In the long run, the economy’s steady state growth rate should equal the rate of population growth.
Technical progress
Technical progress: An improvement in knowledge that enables a higher output to be produced from existing resources. Allows increased output without needing to increase capital per worker.
When including technical progress, production function is rewritten as:
y = Af(k)
where A denotes technology.
If technology improves by ‘g’ per cent per year then A = (1+g).
Effects of technology
Technical progress at rate g per annum increases overall productivity at any given capital-labour ratio.
Production function shifts up.
More output is produced with the same inputs - output per worker increases.
Marginal product of capital increases, which leads to higher rates of investment and capital accumulation.
Saving curve shifts upwards as savings increase.
New technologies can increase productivity, output, and investment, leading to higher standards of living and economic growth.
Total factor productivity
Measures the efficiency of how an economy turns inputs to outputs by finding the ratio of aggregate output (e.g., GDP) to aggregate inputs.
Stock of human capital
The accumulated skills, knowledge, experience, and health of a workforce that contribute to economic productivity.
A larger and more skilled stock of human capital leads to higher wages and living standards, greater innovation and economic growth, more efficient use of physical capital and stronger resilience to economic shocks.
If the UK has a higher stock of human capital per worker than India, its output per worker and living standards will be higher, even if both countries have the same capital-labour ratio.
Effects of COVID-19 on growth
Business failures destroy knowledge and accumulated learning from doing.
Prolonged employment destroyers worker-firm matches that were good for productivity.
Prolonged health concerns changes how we conduct business and organise production.
Prolonged unemployment and health concerns could lead workers to exit the labour force.
Democracy
Democracy: rule of the people; a way of governing which depends on the will of the people.
Democracy has strong indirect effects which contribute to growth. It is associated with higher human capital accumulation, lower inflation, lower political instability, and higher economic freedom.
Democracy is also tied with economic sources of growth, like education levels and lifespan through improvement of educative institutions as well as healthcare.
Costs of increased production of capital goods
Increasing the capital stock will increase GDP in the long-run.
However in the short run, producing more capital goods will have opportunity costs:
- causes fewer consumer goods. People will reduce current consumption to have more in the future.
- reduced leisure time
- possible health and safety risks from rapid capital production
- costs of research and development to improve technology
- cost of education to develop and use new capital
Promoting growth with human capital
Governments supporting education and training programs
Government paying for education. Creates growth by bringing up educated voters and people who are more likely to earn more (add more to the economy and a source of tax revenue) or create technical innovations (increased efficiency and productivity).
Promoting growth with savings and investment
Government policies can encourage new capital formation and saving in the private sector. Increased savings leads to economic growth.
Government can invest directly into capital formation. E.g., construction of infrastructure like roads, bridges, airports, and dams reduces transport costs, increasing market efficiency.
Promoting growth with R&D support
Research and development promotes innovation which can introduce new fields or increase efficiency in existing fields.
Government sponsors research for military and space applications which maintains political and legal framework to support growth.
Promoting growth in least developed
Most countries need institutions to support growth.
Corruption creates uncertainty about property rights and drains financial resources from the country. Regulation discourages entrepreneurship. Taxes discourage risk-taking. Causes markets to not function efficiently. Lack of political stability discourages foreign investment.
Limits to growth
Depletion of some natural resources e.g., limited farmland, fresh water, fossil fuels, iron. Can improve usage of these resources through recycling, more efficient resource gathering, using renewable resources.
Environmental damage and global warming.
Computer models suggest that growth is not sustainable. However this did not necessarily account for new, better products, increased income being used to fund better environmental quality and responses to environmental and economic issues caused from growth.
