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Principles of economics openstax chapter20


Economic Growth

Chapter 20

Average daily caloric consumption

Not only has the number of calories consumer per day increased, so has the amount of food calories that people are able to
afford based on their working wages. (Credit: modification of work by Lauren Manning/Flickr Creative Commons)


Chapter Outline

Labor Productivity and Economic Growth

Components of Economic Growth

Economic Convergence


Recent Economic Growth

modern economic growth: spectacular patterns of economic growth around the world in the last
two centuries, commonly referred to as the period of modern economic growth.

the average person’s standard of living had not changed much for centuries.

Industrial Revolution: the widespread use of power-driven machinery and the economic and
social changes that resulted in the first half of the 1800s

The new jobs of the Industrial Revolution typically offered higher pay and a chance for social

The Industrial Revolution led to increasing inequality among nations


Factors of economic growth


adherence to the rule of law


protection of property rights and contractual rights by a country’s government so that markets
can work effectively and efficiently

If above holds true, legal system considered to be effective (World Bank)

Ranks effectiveness: World average ranking – 2.9

Lowest ranked countries – 1.5 (Afghanistan, Zimbabwe, Central African Republic)


Labor productivity and economic growth

Labor productivity is the value that each employed person creates per unit of his or her input.

Can do more in the same time

Determinants of labor productivity:


Human capital - the accumulated knowledge (from education and experience), skills, and expertise that the
average worker in an economy possesses


Technological change - combination of invention—advances in knowledge—and innovation, which is putting
that advance to use in a new product or service


Economies of scale – cost advantages due to size

Production function - the process of turning economic inputs like labor, machinery, and raw materials
into outputs like goods and services used by consumers


Aggregate Production Functions

An aggregate production function shows what goes into
producing the output for an overall economy.


This aggregate production function has GDP as its output.


This aggregate production function has GDP per capita as
its output. Because it is calculated on a per-person basis,
the labor input is already figured into the other factors
and does not need to be listed separately.

Output per hour worked, US

Output per hour worked is a measure of worker productivity. In the U.S. economy, worker productivity rose more quickly in the
1960s and the mid-1990s compared with the 1970s and 1980s. However, these growth-rate differences are only a few
percentage points per year. Look carefully to see them in the changing slope of the line. The average U.S. worker produced
nearly $105 per hour in 2012. (Source: U.S. Department of Labor, Bureau of Labor Statistics.)

Productivity growth

Some think the productivity rebound of the late 1990s and early 2000s marks the start of a “new economy” built on higher
productivity growth, but this cannot be determined until more time has passed. (Source: U.S. Department of Labor, Bureau of
Labor Statistics.)


“New Economy” Controversy

Resurgence of US productivity in the second half of 1990s

Either start of higher average productivity for decades, or

Just a short-term boost

Sustained economic growth very important for people’s standard of living

even a few percentage points of difference in economic growth rates will have a profound effect
if sustained and compounded over time


Components of economic growth


Physical capital - plant and equipment used by firms and also things like roads (also called

Greater physical capital implies more output


Human capital – increased investment leads to higher long-term productivity


Technology - comprises all the advances that make the existing machines and other inputs produce
more, and at higher quality, as well as altogether new products.

. Capital deepening – increases in the level of capital per person
. E.g. average levels of education

Human capital deepening: US

Rising levels of education for persons 25 and older show the deepening of human capital in the U.S. economy. Even today,
relatively few U.S. adults have completed a four-year college degree. There is clearly room for additional deepening of human
capital to occur. (Source: US Department of Education, National Center for Education Statistics)

Physical capital deepening

The value of the physical capital, measured by plant and equipment, used by the average worker in the U.S. economy has risen
over the decades. The increase may have leveled off a bit in the 1970s and 1980s, which were not, coincidentally, times of
slower-than-usual growth in worker productivity. We see a renewed increase in physical capital per worker in the late 1990s,
followed by a flattening in the early 2000s. (Source: Center for International Comparisons of Production, Income and Prices,
University of Pennsylvania)


Growth accounting

Technology is the most important contributor to US economic growth

Investment in physical capital is essential to growth in labor productivity and GDP per capita,
building human capital is at least as important

Three factors of human capital, physical capital, and technology work together


Economic Convergence

Convergence – low-income countries’ economies grow faster than those of high-income


Favoring convergence

Diminishing marginal returns – marginal gains from human and physical capital decreases

Lower-income countries have higher marginal gains

LIC easier to improve technology

Lessons learned


Against convergence

Improving technology avoids declining marginal returns of capital deepening

Figure 20.7

Imagine that the economy starts at point R, with the level of physical and human capital C 1 and the output per capita at G1. If
the economy relies only on capital deepening, while remaining at the technology level shown by the Technology 1 line, then it
would face diminishing marginal returns as it moved from point R to point U to point W. However, now imagine that capital
deepening is combined with improvements in technology. Then, as capital deepens from C1 to C2, technology improves from
Technology 1 to Technology 2, and the economy moves from R to S. Similarly, as capital deepens from C 2 to C3, technology
increases from Technology 2 to Technology 3, and the economy moves from S to T. With improvements in technology, there is no
longer any reason that economic growth must necessarily slow down.


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