ECON 1012 Week 6 of In Class and Textbook Notes Chapter 11
ECON 1012 Week 6 of In Class and Textbook Notes Chapter 11 Econ 1012
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This 11 page Class Notes was uploaded by Caroline Jok on Monday February 22, 2016. The Class Notes belongs to Econ 1012 at George Washington University taught by Dr. John Volpe in Spring 2016. Since its upload, it has received 87 views. For similar materials see Principles of Economics II in Economcs at George Washington University.
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WEEK 7 NOTES Introduction to Macroeconomics Professor John Volpe ECON 1012 Caroline E. Jok The George Washington University Class 11 ~ Ch. 11 Economic Growth over time around the world: • Economic growth: long run (increases in real gdp) or (real GDP per capita) • Real GDP per Capita = Real Gdp / population • The growth rate of the economy is the annual rate of change of real GD/GDP per capita • In other words: increase the standard of living • Annual rate of change = value in some year = value in previous year /value in previous year • Real GDP per capita and the standard of living are "essentially" the same thing Differences in Incomes across Countries: • High income countries • Newly industrializing countries • Poor countries • Growing gap o Deregulation of prices • Brings about competition • Competition helps reduce cost o Diffusion of technology • Invention = Innovation = commercialization of the invention • Diffusion = moving the technology from one place to the next § Where did the U.S. inventions go? o Low levels of saving and investment o Communism o Government fostering entrepreneurship Economic Models • Explain growth rates in real GDP per capita over the long run • Production function: input (labor, physical capital, national resources, knowledge) output (goods and services) relationship • Technological Change o better machinery and equipment o Increases in human capital o Better means of organizing and managing production o We don't know how to measure • Law of Diminishing returns o As quantity of one input increases, while holding constant the constant of other I inputs, more output is produced o Increase the quantity of that one variable input, increases in output get smaller and smaller o Output will increase at a decreasing rate New Growth Theory: • Model of long run economic growth that emphasizes that technological change is influenced by economic incentives and is so determined by the working of the market system. Old growth: • Technological change is outside of the economic system Class 12 ~ Ch. 11 cont. Old Growth Theory: • Technology is exogenous New Growth Theory: • Technology is endogenous Government's role in knowledge capital generation • Public goods result in free riding • Firms do not enjoy the entire benefit of their knowledge capital • Public good nature of knowledge - Government role: o Protecting intellectual property with patents and copyrights o Subsidizing research and development o Subsidizing education • More knowledge = more output for worker • There are some goods (public goods) you can't stop people from enjoying the benefit of even if they don't contribute • If you invent something, you don't have total control over the knowledge that you develop o Because you can't exclude others from benefitting, you're less inclined to work to increase the knowledge being developed • Factors that increase economic growth o Education: higher education increases productivity of labor o Financial institutions are intermediates' between savers and borrowers, they help move money between those who have ideas and those who have the money to make ideas happen. • Strong financial institution goes a long way to developing knowledge o Transportation networks o Political institutions - people have trust in the system o Property rights o Judicial system that enforces contracts and adjudicates disputes • Patents: give a frim that has knowledge, the right to exclude anyone else from using the discovery for a period of years o Encourage business to engage in &D o Fine for the firm making the discovery o Strong patent laws interfere with diffusion of technology o Weak patent laws discouraged. • Trademark: o Logo or symbol, group of words, distinctive design o Anything that identifies the product in the minds of the consumer s • Knowledge is not excludable • Role of the Entrepreneur Are developing countries catching up to developed countries? • Convergence and divergence • Why are low income countries growing slowly? o Failure to enforce the rule of law o Wars and revolutions o Poor public education and health o Low rates of saving and investment Reading Notes ~ Chapter 11 Long - Run Economic Growth: Sources and Policies • Real GDP per Capita = best measure of standard of living: o Represents ability of average person to buy goods/service • Growth = increase in Real GDP • Why is there a disparity in growth? 11.1: Economic Growth overtime and around the World • Economic Growth from 1,000,000 BC to the Present o Hunting/gathering/Sustenance living o Framing - production of food, clothing, shelter and simple tools o Industrial Revolution: application of mechanical power to the production of goods, beginning in England around 1750 • Started with the production of cloth by steam engines • Mechanical speed • Long-run economic growth: Sustained increases in real GDP/capita raised living standards • Why Did the Industrial Revolution Begin in England? o Institutions in England differed significantly from those in other countries in ways that aided economic growth. o Glorious Revolution of 1688 - key turning point • British court system became independent of the king • Entrepreneurs had the incentive to make investments • Small Differences in Growth Rates are Important o Small differences in growth rates can have a large effect o Compounding: magnifi cation of small differences o Applies to economic growth rate and interest rate o Long run: small differences in economic growth rates result in big differences in living standards. Why do Growth Rates Matter? • o An economy that grows too slowly fails to raise living standards o Low growth = missed opportunities to improve lives of the citizens • The Rich get richer and… o High income countries • Industrial countries • Developed countries • Australia • Canada • Japan • New Zealand • US western Europe o Poor countries • Developing countries • Africa • Asia • Latin America o Newly Industrializing Countries • High rates of Growth • Singapore • South Korea • Taiwan • Is Income all that Matters o More income, the more goods/services o Countries with the lowest quality of life are making th e fastest progress improving it (health, Education, civil and political liberties) o Improvements partially accredited to types of government • Democracies • Political instability has decreased in many countries o Increases in income within a particular country are typically not the main causes of improvements in a country's standard of living in terms of health, education, individual rights, political stability o Some increases in living standards don't require income o Key factors in increasing s tandards: increasing technology and knowledge 11.2: What Determines How Fast Economies Grow? • Economic Growth Model: model that explains growth rates in real GDP per capita over the long run • Labor productivity: The quantity of goods/services that can be pro duced by one worker or by one hour of work • Technological change: Change in the quantity of output a firm can produce using a given quantity of inputs o Better machinery and equipment o Increasing human capital • Physical capital: computers, factory buildings, ma chine tools, warehouses, trucks • The more physical capital, the more human capital • Human capital: accumulated knowledge and skills that workers acquire from education and training or from life experiences o Better means of organizing and managing production • Managers can do a better job of organizing production = labor productivity increases • Just in time system: assembling goods from parts that arrive at the factory at exactly the time they are needed § Fewer workers needed o Technological change is not the same th ing as more physical capital o New capital can embody technological change • The Per-Worker Production Function o Real GDP per capita increases with • Quantity of capital available to workers • Technological change • Increases in real GDP per hour worked and increases in capital per hour worked o Per worker Production function: relationship between real GDP per hour worked and capital per hour worked holding the level of technology constant o K = capital o L = Labor o Y = real GDP o Real GDP per hour - Y/L o Capital per hour = K/L o Technological change using graph - shifting up the curve o Law of diminishing returns: add more of one input to a fixed quantity of another input, output increases by smaller additional amounts • Which is more important for economic growth: more capital or technological change o Technological change helps economies avoid diminishing returns to capital • Technological Change: The Key to Sustaining Economic Growth o Technological change shifts up the production function and allows the econom y to produce more real GDP per hour worked with the same quantity of capital per hour worked o Further increases in technology that shift the economy to higher production functions results in further increases in real GDP per hour worked o In the long run, a country will experience an increasing standard of living only if it experiences continuing technological change • What explains the economic failure of the Soviet Union? o Formed from the old Russian Empire o Communism: centrally planned economy - government owned businesses, and made all production and pricing decision o Soviet Union had slow technological change o Soviet union didn't have new technologies due to a centrally planned economy o Pay dependent on output o Vs. US - Entrepreneurs were driven by competition • New Growth Theory o New growth theory: model of long -run economic growth that emphasizes that technological change is influenced by economic incentives and so is determined by the working of the market system o Knowledge capital: key determinant of economic th eory o At the firm level, knowledge capital is subject to diminishing return o At the level of the entire economy, knowledge capital is increasing returns • Knowledge is available to everyone • Nonexcludable • Nonrival • Results in free riding o Government policy incre asing the accumulation of Knowledge capital • Protecting intellectual property with patents and copyrights § Patent: exclusive right to produce a product for a period of 20 years • Subsidizing research and development • Subsidizing education • Joseph Schumpeter and Creative Destruction o Finance minister of Austria o Emphasized his view that new products unleash a "gale of creative destruction" that drives older products out of the market. o Ex: DVD drove the VHS tapes off the market o Entrepreneur is central to economic g rowth • The profits an entrepreneur hopes to earn provide the incentive for bringing together the factors of production (labor, capital, and natural resources) to start new firms and introduce new goods/services 11.3 Economic Growth in The United States • Economic growth mode;: shows average annual growth rates in real GDP per hour worked since 1800 • Industrial Revolution: U.S. firms increased the quantities of capital per hour worked o New technologies are the driving factor • Living standards grew steadily but slowly • Technological change has been institutionalized • Economic Growth in the United States since the 1950s o Continuing technological change = avoidance of diminishing returns o Until the 1970s growth rate was accelerating o Slowed but continued to increase o 1990s growth rate picked up again • What caused the productivity slowdown of 1974 - 1995 o Some: Productivity didn't slow, it only appears to have slowed due to inaccuracies of measuring productivities • Post 1970s services bec ame a larger fraction of GDP than goods • More difficult to measure increases in the output of services than increases in outputs of goods • GDP doesn't measure convenience • Issues accounting for improvements in the environment and in health and safety o Some: deterioration in U.S. educational system contributed to the slowdown in growth o Skills required to perform many jobs may have increased o All high income countries experienced a slowdown in growth between the 70s and90s • Is the United States Headed for Anothe r Productivity Slowdown? o Productivity growth: measured by changes in real GDP per hour worked o New economy = information technology economy • Caused higher productivity growth? • Faster data processing o Economists who are optimistic about IT are often optimi stic about the economy 11.4 Why Isn't the Whole World Rich? • Become rich: o Increase quantity of capital per hour worked o Use the best available technology • Both have economic incentives in poor countries • The economic growth model predicts that poor countries will grow faster than rich countries • Catch up: Convergence: prediction that the level of GDP per capita in poor countries will grow faster than in the rich countries. • Catch-up: Sometimes but not always o Horizontal axis: shows t he initial level of real GDP per capita o Vertical: shows the rate at which real GDP per capita is growing o Catch-up among the High-Income Countries: • High income countries that had the lowest incomes in 1960: Taiwan, Korea, Singapore, grew the fastest • Countries with the highest incomes: US and Switzerland grew the slowest o Are the developing Countries catching up to the High -Income Countries? • No consistent relationship between the level of real GDP I n1960 and growth from then to 2010 • Some countries had negati ve economic growth • Some middle income countries in 1960 such as Venezuela hardly grew • Why Haven't Most western European Countries, Canada, and Japan Caught Up to the United States? o Over the past 20 years, other high -income countries have actually fallen further behind the United States rather than catching up to it o Why have other high -income countries had trouble closing the gap with the United States • Greater flexibility of U.S. labor markets § In European countries, government regulations make it difficult for firms to fire workers, therefore workers are reluctant to hire workers § United States has high job mobility which increases labor productivities § Europe has work rules that limit the flexibility of firms to implement new technologies. • Greater efficiency of U.S. Financial system § Large corporations can raise funds by selling stocks and bonds § U.S. corporations benefit from the efficiency of U.S. financial markets § Level of legal protection of investors is relatively high in U.S. financial m arkets § Quick ability sell and trade stocks and bonds § Liquidity serves to attract investors to U.S. markets § Smaller firms unable to issue stocks and bonds § Venture capital firms: raise funds from institutional investors and wealthy individuals, often becomes a part owner of the start up • Why Don't More Low -Income Countries Experience Rapid Growth? o Why are many low -income countries growing so slowly: • Failure to enforce the rule of law § Property rights: rights of individuals or firms have to the exclusive use of their property, including the right to buy or sell it. § Rule of law: ability of a government to enforce the laws of the country with respect to protecting private property and enforcing contracts • Wars and revolutions § Wars and violent changes of governm ent § Ending a war has a positive effect on growth • Poor public education and health § Human capital is one of the determinants of labor productivity § Low-income countries have weak public school systems § Workers have few skills necessary § Poor health care means more sickness and less productivity • Low rates of saving and investment § Funds can come from owners, friends and families as well as bank loans, stocks and bonds § Low savings rates in developing countries can contribute to a vicious cycle of poverty • Benefits of Globalization o Foreign direct investment: purchase or building by a corporation of a facility in a foreign country o Foreign portfolio investment: The purchase by an individual or a firm of stocks or bonds issued in another country o 40s through the 70s many developing countries closed themselves off from the global economy . • Global trading and financial system collapsed as a result of the Great Depression • Recent independence from colonial powers o Globalization: process of countries becoming more open to foreign trade and investment • Makes it easier for them to obtain technology and investment funds 11.5 Growth Policies • Enhancing Property Rights and the Rule of Law o Market systems don't work well unless property rights are enforced o Government corrupt ion is an issue • Will China's Standard of Living Ever Exceed That of the United States? o Growth in china skyrocketed o However • Less successful in developing new technologies • Good part of China's growth is due to the transition from a centrally planned economy to a market economy • China's economic growth has depended on moving workers from agriculture to manufacturing o Issues: • Increasing wages • Demographic • Autocratic government • Improving Health and Education o As people's health increases they become stronger and less susceptible to diseases and more productive o Rising income result from economic growth o Brain drain: highly educated and successful people leaving developing countries for high income countries • Policies that promote technologic al change o Technological change is more important than increases in capital in explaining long run growth o In high income countries, government policies can aid the growth of technology by subsidizing research and development • Policies that Promote Saving an d Investment o Firms turn to loanable funds market to finance expansion o Policies increasing incentives to save and invest increases the level of loanable funds and GDP per capita o Investment tax credits: allow firms to deduct from their taxes on their profit s also increase the after tax return on investments • Is Economic Growth Good or Bad? o Assumed economic growth is desirable o Arguments against further economic growth reflect concern about the effects of growth on the environment or concern about the effects of the globalization process that has accompanied economic growth.