2 ECONOMIC
GROWTH
After studying this chapter, you will be able to:
Define and calculate the economic growth rate and
explain the implications of sustained growth
Describe the economic growth trends in the United
States and other countries and regions
Explain what makes potential GDP grow
Explain the sources of labor productivity growth
Explain the theories of economic growth and policies to
increase its rate
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How Potential GDP Grows
What Makes Potential GDP Grow?
We begin by dividing real GDP growth into the forces
that increase:
Growth in the supply of labor
Growth in labor productivity
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How Potential GDP Grows
Growth in the Supply of Labor
Aggregate hours, the total number of hours worked by
all the people employed, change as a result of changes
in:
1. Average hours per worker
2. Employment-to-population ratio
3. The working-age population growth
Population growth increases aggregate hours and real
GDP, but to increase real GDP per person, labor must
become more productive.
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How Potential GDP Grows
The Effects of Population Growth
An increase in population increases the supply of labor.
With no change in the demand for labor, the equilibrium
real wage rate falls and the aggregate hours increase.
As aggregate hours increase, potential GDP increases.
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How Potential GDP Grows
Figure 23.9(a) illustrates
the effects of population
growth in the labor
market.
The labor supply curve
shifts rightward.
The real wage rate falls …
and aggregate hours
increase.
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How Potential GDP Grows
As aggregate hours
increase, potential GDP
increases.
Because of the
diminishing returns, the
increased population …
increases real GDP, …
but decreases real GDP
per hour of labor.
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How Potential GDP Grows
Growth of Labor Productivity
Labor productivity is the quantity of real GDP produced
by an hour of labor.
Labor productivity equals real GDP divided by aggregate
labor hours.
If labor becomes more productive, firms are willing to
pay more for a given number of hours so the demand
for labor increases.
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How Potential GDP Grows
Figure 23.10 shows the
effect of an increase in
labor productivity.
The increase in labor
productivity shifts the
production function
upward.
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How Potential GDP Grows
In the labor market:
An increase in labor
productivity increases
the demand for labor.
With no change in the
supply of labor, the real
wage rate rises …
and aggregate hours
increase.
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How Potential GDP Grows
And with the increase in
aggregate hours,
potential GDP increases
from B to C.
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Why Labor Productivity Grows
Preconditions for Labor Productivity Growth
The fundamental precondition for labor productivity growth
is the incentive system created by firms, markets,
property rights, and money.
With preconditions for labor productivity growth in place,
three things influence its pace:
Physical capital growth
Human capital growth
Technological advances
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Why Labor Productivity Grows
Physical Capital Growth
The accumulation of new capital increases capital per
worker and increases labor productivity.
Human Capital Growth
Human capital acquired through education, on-the-job
training, and learning-by-doing is the most fundamental
source of labor productivity growth.
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Why Labor Productivity Grows
Technological Advances
Technological change—the discovery and the application
of new technologies and new goods—has contributed to
increasing labor productivity.
Figure 23.11 on the next slide summarizes the process of
growth.
It also shows that the growth of real GDP per person
depends on real GDP growth and the population growth
rate.
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Why Labor Productivity Grows
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Growth Theories, Evidence,
and Policies
Policies for Achieving Faster Growth
Growth accounting tells us that to achieve faster economic
growth we must either increase the growth rate of capital
per hour of labor or increase the pace of technological
change.
The main suggestions for achieving these objectives are
Stimulate Saving
Saving finances investment. So higher saving rates might
increase physical capital growth.
Tax incentives might be provided to increase saving.
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Growth Theories, Evidence,
and Policies
Stimulate Research and Development
Because the fruits of basic research and development
efforts can be used by everyone, not all the benefit of a
discovery falls to the initial discoverer.
So the market might allocate too few resources to research
and development.
Government subsidies and direct funding might
stimulate basic research and development.
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Growth Theories, Evidence,
and Policies
Improve the Quality of Education
The benefits from education spread beyond the person
being educated, so there is a tendency to under invest in
education.
Provide International Aid to Developing Nations
If rich countries give financial aid to developing countries,
investment and growth will increase.
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Growth Theories, Evidence,
and Policies
Encourage International Trade
Free international trade stimulates growth by extracting all
the available gains from specialization and trade.
The fastest growing nations are the ones with the fastest
growing exports and imports.
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