CHAP 10

• Small differences in income growth rates make enormous differences in levels of income over a few decades.
• Benefits of Economic Growth

  • Rising Average Material Living Standards
  • Economic growth improves average material living standards
  • Economic growth changes consumption patterns
  • Economic growth leads to demand for a cleaner environment
• In recent years, the majority of aggregate income growth in many countries has been accruing to the top earners in the income distribution.
• While average per capita incomes have been rising, there has also been a rise in income inequality.
• Poverty and income inequality are important challenges for public policy.
• Case Against Economic Growth

  Growth is not sustainable

  Growth may not increase overall well-being
• Costs of Economic Growth

  • Forgone Consumption
  • Social Costs
• Forgone Consumption

  Economic growth is achieved by consuming fewer goods today.
• Social Costs

  The process of economic growth is disruptive for some businesses and workers.
• Four 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.
• Long-Run Analysis

  1. Real GDP equals desired consumption plus desired investment

  2. Real GDP adjusts to determine equilibrium

  3. Desired saving equals desired investment
• Private saving


  Y* − T − C
• Public saving

  T − G
• National saving

  NS = Y*−T − C + (T − G)

  or NS = Y* − C − G
• An increase in household consumption or government purchases implies a reduction in national saving.
• The supply curve for national saving and the investment demand curve make up the economy’s market for financial capital.
• In the long run, the condition that desired national saving equals desired investment determines the equilibrium real interest rate.
• An increase in the supply of national saving reduces the real interest rate and encourages more investment.
• The higher rate of investment leads to a higher growth rate of potential output.
• An increase in the demand for investment pushes up the real interest rate and encourages more saving by households.
• The higher rate of saving (and investment) leads to a higher growth rate of potential output.
• The figure shows a positive relationship between investment rates and growth rates, as predicted by our model.
• Neoclassical Growth Model


  GDP = FT (L, K, H)<|>L = labour<|>K = physical capital<|>H = human capital<|>T = technology
• Properties of the Aggregate Production Function

  • Diminishing marginal returns
  • Constant returns to scale
• In the Neoclassical model with diminishing marginal returns, increases in population lead to increases in GDP but an eventual decline in material living standards.
• Capital accumulation leads to improvements in material living standards, but these improvements become smaller with each additional increment of capital.
• If capital and labour grow at the same rate, GDP will increase.
• Technological change is assumed to be exogenous.
• New knowledge can contribute to the growth of potential output, even without capital accumulation or labour-force growth.
• Technological improvements are contained in the new capital goods.
• Fear of widespread unemployment caused by technical change is unfounded.
• As long as labour markets continue to adjust to changes in the demand and supply for labour, the overall level of employment will grow in line with the population.
• If overall technological progress leads to an increased demand for skilled workers, those most able to adapt are the ones most likely to prosper.
• Endogenous Technological Change

  Technological change is responsive to economic signals<|>Growth is achieved through costly, risky, innovative activity
• Sources of increasing returns

  • Market-development costs
  • The Economics of Ideas
• The years since WWII have seen a rapid acceleration in the consumption of the world’s resources.
• The world’s current resources and its present capacity to cope with pollution and environmental degradation are insufficient to accomplish the rise in global living standards with present technology.
• Most economists agree that absolute limits to growth, based on the assumptions of constant technology and fixed resources, are not relevant.
• Technology changes continually, as do available stocks of resources.