Lecture Macroeconomics (9/e): Chapter 10 - David C. Colander

Chapter 10 - The classical long-run policy model: Growth and supply-side policies. After reading this chapter, you should be able to: Define growth, list its benefits and costs, and relate it to living standards; discuss the relationship among markets, specialization, and growth; list five important sources of growth.

Queen Elizabeth owned silk stockings. The capitalist  achievement does not typically consist in providing  more silk stockings for queens but in bringing them  within the reach of factory girls in return for steadily  decreasing amounts of effort.

— Joseph Schumpeter

The Classical Long-Run Policy Model:

Growth and Supply-Side Policies

Chapter Goals

Ø Define growth, list its benefits and costs, and

relate it to living standards

specialization, and growth

Ø List five important sources of growth

be turned into growth

Growth and the Economy’s Potential Output

Ø Growth is an increase in potential output

Ø Potential output is the highest amount of output an

economy can produce from existing production processes

and resources

Ø Productivity is output per unit of input

Ø The long-run growth focus is on how to increase potential

output

• Say’s Law is that supply creates its own demand

Ø The short-run focus is on how to get the economy operating

at its potential

Importance of Growth for Living Standards

make huge differences

Ø The rule of 72 states:

year and the U.S per capita income of $50,000

grows 1% per year:

• Within 27 years per capita income in China will

surpass that in the U.S and after 9 more years will

be significantly higher

Markets, Specialization, and Growth

Ø Markets, specialization, and the division of labor

increase productivity and growth

• Specialization is the concentration of individuals

on certain aspects of production

• Division of labor is the splitting up of a task to

allow for specialization of production

have on the distribution of income

Ø Even though growth isn’t evenly distributed, it generally

raises the incomes of the poor

Per Capita Growth

Ø Per capita output is total output divided by total population

Ø Per capita growth means the country is producing more

goods and services per person

• Per capita growth = % Δ in output – % Δ in population

because it takes into account how income is distributed

The Sources of Growth

Economists identify five important sources of growth:

Growth-Compatible Institutions

economic growth

themselves, they work harder

of limited liability, which gives stockholders an

incentive to invest their savings in large enterprises

Ø Informal property rights limit borrowing by the poor, and

hence limit growth

Investment and Accumulated Capital

Ø Although capital is a key element in growth, capital

accumulation does not necessarily lead to growth

includes:

• Human capital are skills that workers gain from

experience, education, and on-the-job training

• Social capital is the habitual way of doing things

that guides people in how they approach

Technological Development

Ø Technology is the way we make goods and supply

services

services we buy fuel growth

Ø Advances in technology shift the production possibility

curve outward by making workers more productive

and communications have helped fuel U.S growth

The Classical Growth Model

focuses on the role of capital accumulation in the

growth process

capital an economy has, the faster it will grow

policy advice on how to increase investment because

saving leads to growth

The Law of Diminishing Marginal

Productivity

because increases in technology and capital

overwhelmed diminishing marginal productivity

Ø Without growth in technology, investment will not

generate sustained growth

economy does, it:

positive externalities which is the key to growth

• Positive externalities are positive effects on others not taken into account by the decision

New Growth Theory

Ø New growth theory is a theory that emphasizes the

role of technology in the growth process

growth

Tech

Chapter Summary

an economy can produce when both labor and capital are

fully employed

production possibility curve out, allowing an economy to

produce more goods

services per person

institutions (2) capital accumulation (3) available resources

Chapter Summary

investment that is necessary for growth and the interest

rate equilibrates saving and investment

the growth process

Ø Policies that are good for growth are those that: (1)

encourage saving and investment, (2) formalize property

rights, (3) provide the right kind of education, (4)

encourage technological innovation, and (5) take

advantage of specialization