Chapter 24 Macroeconomics- Economic Growth and the Wealth of Nations

Macroeconomics Chapter 24: Economic Growth and the Wealth of Nations Importance of Economic Growth • Economic growth: the percentage change in real per capita GDP • Wealthier societies have better living standards (higher life spans, more access to water, food, and medicine, better education, etc) • Everyone was poor once and some countries just…stayed poor • Historical data show that sustained economic growth is a relatively modern phenomenon. Measuring Economic Growth • economic growth ≈ %Δ in nominal GP − %Δ price level − %Δ population • How growth rate impacts income level o With a constant percentage increase in income, it becomes exponential o at a growth rate of 2%, it takes only about 35 years for income to double o Rule of 70: If the annual growth rate of a variable is x%, the size of that variable doubles approximately every 70 ÷ x years. ▪ small and consistent growth rates, if sustained for a decade or two, can greatly improve living standards Resources • Resources: factors of production, inputs used to produce goods and services • discovery or cultivation of new resources is a source of economic growth • Three kinds of resources: o Natural resources: physical land and the inputs that occur naturally in or on the land ▪ Ex: coal, beaches, diamond, weather ▪ Geography can contribute to economic growth and capacity; it also facilitates weather, trade, and disease control o Physical capital: tools and equipment used in the production of goods and services ▪ Ex: factories, roads, bridges, computers ▪ As the quantity of physical capital per worker rises, so does output per worker ▪ many of the early contributions to growth theory focused on the role of physical capital. As a result, much international aid went into capital o Human capital: resource represented by the quantity, knowledge, and skills of the workers in an economy ▪ economic growth requires more output per capita ▪ human capital isn’t just the workers, but their knowledge and skill so it is possible to increase human capital through education and training Technology • Technology: knowledge available for use in production • Technology advancement: introduces new techniques or methods so that firms can produce more valuable outputs per unit of input • Technological innovations are clustered in particular locations in large part because of the institutions that foster economic growth. Institutions • Institution: a significant practice, relationship, or organization in a society. • Institutions are the official and unofficial conditions that shape the environment in which decisions are made • Private property rights: individuals can own property and when they use said property in production, they own the output o Incentivizes output (greatest incentive for voluntary production) o The Xiaogang agreement in China introduced private property rights and led to an agricultural boom in the late 1970s. • Political stability: the consistency and calmness of a nation o Political instability is a disincentive for investment. o Consistent and trustworthy enforcement of a nation’s laws is crucial for economic growth o Corruption impedes economic growth o The nations with the least corruption have average per capita GDP of $38,350, but the most corrupt nations have average per capita GDP of just $4,785. o production decisions without concern for corrupt government. o Political stability and the rule of law ensure that investments in physical and human capital can be made with less risky returns • Competitive Markets: When markets aren’t competitive, people who want to participate face barriers to entry, which inhibit competition and innovation o Many nations monopolize key industries or establish government ownership, limiting growth o Everyone benefits from global productivity o Encourages specialization • International trade: inflow of foreign savings has helped to keep US interest rates low o Opportunities for investment expand if there is access to savings from around the globe o Restrictions on the flow of capital across borders handcuff domestic firms, which are forced to seek funds solely from domestic savers. • Efficient taxes: taxes sufficient to fund the activities of government while impeding production and consumption decisions as little as possible o taxes must be high enough to support effective government but can’t tax activities fundamental to economic growth or the activities will be discouraged o Taxing income = taxing output = taxing GDP • Stable Money and Prices: unpredictable inflation diminishes future growth possibilities o The Fed tries to reduce incentives for politically motivated monetary policy, typically leading to higher more variable inflation o Stable money and prices allow people to make long-term production decisions with minimal risk. Extra Notes • • Formulas: o %Δ real per capita GDP = %Δ real GDP – %Δ population o %Δ real GDP=%Δ real per capita GDP+%Δ population o %Δ real GDP = %Δ nominal GDP – %Δ prices o %Δ nominal GDP=%Δ real GDP + %Δ prices o %Δ nominal GDP=%Δ real per capita GDP+%Δ population + %Δ prices o economic growth ≈ %Δ in nominal GP − %Δ price level − %Δ population o economic growth ≈ %Δ real GDP − %Δ population o Inflation rate= %Δ in nominal GP-economic growth rate-population growth percent change in price level is inflation -.3=1.5-