Chapter 08 – Economic Growth
CHAPTER EIGHT
ECONOMIC GROWTH
CHAPTER OVERVIEW
This chapter looks at the impact of economic growth in general. Although punctuated by periods of
cyclical instability, economic growth in the United States has been impressive. For example, during the
last half century, real output increased over 800 percent in absolute terms and over 200 percent on a per
capita basis. We also question whether the United States is achieving a “new economy” which might
deliver a stronger future rate of growth. Finally, we explore both positive and negative aspects of growth.
WHAT’S NEW
The only major change is a new ‘Last Word’ on whether economic growth can withstand the changing
demographics around the world.
There is also a new Quick Review (QR 8.5) at the end of the chapter.
All data and tables have been updated.
INSTRUCTIONAL OBJECTIVES
After completing this chapter, students should be able to:
1. Define two measures of economic growth.
2. Explain why growth is a desirable goal.
3. Identify two main sources of growth.
4. Explain and apply the “rule of 70.”
5. Give average long-term growth rates for U.S. and qualifications of raw data.
6. Show economic growth using production possibilities analysis and aggregate demand-aggregate
supply analysis.
7. Describe the growth record of the U.S. economy since 1950, including two measures of its
long-term growth rates.
8. Identify six major factors that contributed to U.S. economic growth according to empirical studies.
9. List three primary reasons for the rise in the average rate of productivity growth in the United
States since 1995.
10. List five reasons for increasing returns during the period of productivity growth.
11. Evaluate the potential for the average rate of productivity growth to be a permanent phenomenon.
12. Identify and explain the arguments for and against economic growth.
13. Define and identify terms and concepts at the end of the chapter.
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Chapter 08 – Economic Growth
COMMENTS AND TEACHING SUGGESTIONS
1. The record of U.S. economic growth is made more meaningful if you can take time to put it in
comparative perspective. World Bank publications such as the World Development Report or
World Bank Atlas give population and growth statistics for most countries of the world.
2. Global Perspective 8.1 gives an interesting (although not unfamiliar) comparison of academic
achievement of eighth-grade math and science scores. It may be useful to discuss how the U.S.
still manages to achieve solid economic growth and what numbers like these suggest for long-term
growth prospects.
3. An interesting source for debate on whether or not growth is desirable would be the classic, E. F.
Schumacher’s Small is Beautiful. Other books that touch on U.S. economic growth issues are
Lester Thurow’s Zero–Sum Society and Zero-Sum Solution and Wallace Peterson’s Our Overloaded
Economy. Many of the articles and books related to environmental issues highlight the gap
between rich and poor.
4. The information economy raises many questions about concepts we teach in economics. Two
excellent books are Information Rules and Blown to Bits. The January 1, 2000, issue of The Wall
Street Journal had an entire section entitled “Good-Bye Supply and Demand.”
5. To give students greater appreciation of the impact of technological change over the past 100 years,
you may wish to share with them this “Concept Illustration” that previously appeared on the
website in the “Analogies, Anecdotes, and Insights” section.
Concept Illustration … Technological change and economic growth
Economist J. Bradford DeLong points out that technological change has brought forth goods and
services that would have been simply unimaginable a century ago.*
I believe there is…insight to be gained [on this matter by] examining Edward Bellamy’s (1887)
Looking Backward. Although the prose is wooden to our sensibilities, the book was a best-seller in
the late nineteenth century, because it gave a very hopeful vision of how economic growth would
bring us utopia.
The narrator goes forward in time from 1895 to 2000, and his host of the future asks, “Would you
like to hear some music? The narrator expects his host to play the piano—a social accomplishment
of upper-class women around 1900. Instead, the narrator is stupefied to find his host “merely
touched one or two screws,” and immediately the room “filled with music; filled, not flooded, for
by some means, the volume of the melody has been perfectly graduated to the size of the
apartment. ‘Grand!’ I cried. ‘Bach must be at the keys of that organ; but where is the organ?’” He
learns that his host has called the orchestra on the telephone.
In Bellamy’s late twentieth-century utopia you can dial up a live orchestra and then put it on the
speakerphone. You even have a choice of orchestras—there are four at any moment. Bellamy’s
narrator then says, “if we [in the nineteenth century] could have devised an arrangement for
providing everybody with music in their homes, perfect in quality, unlimited in quantity, suited to
every mood, we would have considered the limit of human felicity [ecstasy] already attained …”
What if someone were to take Edward Bellamy to Tower Records today? His heart would stop. Yet
we do not give thanks for our [CD players] and our CD collections for having brought us to the
limit of human felicity. We rarely think about them at all: we take them for granted … Modern
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Chapter 08 – Economic Growth
economic growth has been so great as to carry us off the scale of measurement that past generations
could have imagined.
*J. Bradford DeLong, “How Fast is Modern Economic Growth?” Economic Letter (Federal Reserve
Bank of San Francisco), October 16, 1998, pp. 1-2.
LECTURE NOTES
I. Introduction
A. Learning objectives – After reading this chapter, students should be able to:
1. List two ways that economic growth is measured.
2. Define “modern economic growth” and explain institutional structures needed for an
economy to experience it.
3. Identify the general supply, demand, and efficiency forces that give rise to economic
growth.
4. Describe “growth accounting” and the specific factors accounting for economic growth in
the United States.
5. Explain why the trend rate of U.S. productivity growth has increased since the earlier
1973 – 1995 period.
6. Discuss differing perspectives as to whether growth is desirable and sustainable.
II. Economic Growth.
A. Two definitions of economics growth are given.
1. The increase in real GDP, which occurs over a period of time.
2. The increase in real GDP per capita, which occurs over time. This definition is superior
if comparison of living standards is desired. For example, China’s 2012 GDP was
$12,380 billion compared to Denmark’s $332 billion, but per capita GDP’s were $9100
and $37,700 respectively.
3. Either figure, the GDP or GDP per capita, growth can be negative.
4. Growth in real GDP does not guarantee growth in real GDP per capita. If the growth in
population exceeds the growth in real GDP, real GDP per capita will fall.
B. Growth is an important economic goal because it means more material abundance and ability
to meet the economizing problem. Growth lessens the burden of scarcity.
C. The arithmetic of growth is impressive. Using the “rule of 70,” a growth rate of 2 percent
annually would take 35 years for GDP to double, but a growth rate of 4 percent annually
would only take about 18 years for GDP to double. (The “rule of 70” uses the absolute value
of a rate of change, divides it into 70, and the result is the number of years it takes the
underlying quantity to double.)
D. Main sources of growth are increasing inputs or increasing productivity of existing inputs.
1. About one-third of U.S. growth comes from more inputs.
2. About two-thirds come from increased productivity.
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Chapter 08 – Economic Growth
E. Growth Record of the United States (Table 8.1) is impressive.
1. Real GDP has increased over six fold since 1950, and real per capita GDP has risen over
threefold. (See columns 2 and 4, Table 8.1)
2. Rate of growth record shows that real GDP has grown about 3.2 percent per year since
1950 and real GDP per capita has grown about 2 percent per year. But the arithmetic
needs to be qualified.
III. Modern Economic Growth
A. Modern economic growth is characterized by sustained ongoing increases in living standards
that can cause dramatic increases in the standard of living within a generation.
B. Economic historians informally date the start of the Industrial Revolution to the year 1776,
when Scottish inventor James Watt perfected a powerful and efficient steam engine.
C. The Uneven Distribution of Growth
1. Modern economic growth has spread only slowly from its British birthplace. It first
advanced to France, Germany, and other parts of Western Europe in the early 1800’s
before spreading to the Untied States, Canada, and Australia by the mid 1800’s.
2. The different starting dates for modern economic growth in various parts of the world are
the main cause of the vast differences in per capita GDP levels seen today.
3. Figure 8.1 shows what economists have called the great divergence in income levels
around the world as a result of different rates of, and starting dates for, modern economic
growth.
D. Catching Up is Possible
1. Countries that began modern economic growth more recently are not doomed to be
permanently poorer than the countries that began modern economic growth at an earlier
date.
2. The poorer ‘follower countries’ can grow much faster because they can simply adopt
existing technologies from rich ‘leader countries’.
3. Table 8.2 shows both how the growth rates of leader countries are constrained by the rate
technological progress as well as how certain follower countries have been able to catch
up by adopting more advanced technologies and growing rapidly.
4. Consider This … Economic Growth Rates Matter
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Chapter 08 – Economic Growth
IV. Institutional Structures That Promote Modern Economic Growth
A. Table 8.2 demonstrates that poorer follower countries can catch up. But how does a country
start that process.
B. Economic historians have identified several institutional features that promote and sustain
modern economic growth.
1. Strong Property Rights
2. Patents and copyrights (see the Consider This … Patents and Innovation)
3. Efficient financial institutions
4. Literacy and widespread education
5. Free trade
6. A competitive market system
V. Determinants of Growth
A. Four supply factors relate to the ability to grow.
1. The quantity and quality of natural resources,
2. The quantity and quality of human resources,
3. The supply or stock of capital goods, and
4. Technology.
B. Two demand and efficiency factors are also related to growth.
1. Aggregate demand must increase for production to expand.
2. Full employment of resources and both productive and allocative efficiency are necessary
to get the maximum amount of production possible.
VI. Production Possibilities Analysis (Figure 8.2)
A. Growth can be illustrated with a production possibilities curve (Figure 8.2), where growth is
indicated as an outward shift of the curve from AB to CD.
1. Aggregate demand must increase to sustain full employment at each new level of
production possible.
2. Additional resources that shift the curve outward must be employed efficiently to make
the maximum possible contribution to domestic output.
3. For the economy to achieve the maximum increase in value, the optimal combination of
goods must be achieved (allocative efficiency).
VII. Accounting for growth (an attempt to quantify factors contributing to economic growth)
A. More labor input is one source of growth. Labor force has grown by 1.6 million workers per
year for the past 56 years and accounts for about one-third of total economic growth.
B. The growth of labor productivity contributed to only about half of the growth from 1973-
1993, but was responsible for all of it from 2001-2007, and is expected to account for about
92% of the growth between 20011 and 2021.
C. Consider This Women, the Labor Force, and Economic Growth
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Chapter 08 – Economic Growth
1. The percentage of women working in the paid labor force has risen from 40 percent in
1960 to 60 percent today.
2. Women’s productivity has increased with greater investments in human capital.
Productivity increases have raised women’s wages and increased the opportunity cost of
staying home.
3. Reduced birthrates, growth in industries typically attracting women workers, urban
migration, increased availability of part-time jobs, and antidiscrimination laws have all
increased labor market access for women.
D. Technological advance, the most important factor in productivity growth, accounts for 40
percent of productivity growth.
E. Increases in quantity of capital are estimated to explain about 30 percent of productivity
growth.
F. Education and training improve the quality of labor, and account for about 15 percent of
productivity growth. (See Figure 8.4)
G. Improved resource allocation and economies of scale also contribute to growth and explain
about 15% of total productivity growth.
1. Economies of scale occur as the size of markets and firms that serve them have grown.
2. Improved resource allocation has occurred as discrimination disappears and labor moves
where it is most productive, and as tariffs and other trade barriers are lowered.
VIII. The Rise in the Average Rate of Productivity Growth
A. Improvement in standard of living is linked to labor productivity – output per worker per
hour (Figure 8.5).
B. The U.S. is experiencing a resurgence of productivity growth based on innovations in
computers and communications, coupled with global capitalism. Since 1995 productivity
growth has averaged 2.8% annually – up from 1.5% over the 1973-95 period. The “Rule of
70” projects real income will double in 24 years rather than 50 years.
C. Much of the recent improvement in productivity is due to “new economy” factors such as:
1. Microchips and information technology are the basis for improved productivity. Many
new inventions are based on microchip technology.
2. New firms and increasing returns characterize the new economy.
a. Some of today’s most successful firms didn’t exist 25 years ago: Dell, Compaq,
Microsoft, Oracle, Cisco Systems, America Online, Yahoo and Amazon.com are just
a few of many.
b. Economies of scale and increasing returns in new firms encourage rapid growth.
3. Sources of increasing returns include:
a. More specialized inputs.
b. Ability to spread development costs over large output quantities since marginal costs
are low.
c. Simultaneous consumption by many customers at the same time.
d. Network effects make widespread use of information goods more valuable as more
use the products.
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Chapter 08 – Economic Growth
e. Learning increases with practice.
4. Global competition encourages innovation and efficiency.
D. Even if average growth rates in productivity and real output remain higher over time,
business cycle fluctuations (i.e. recessions) can still occur.
E. Skepticism about long-term continued growth remains, and only time will tell.
IX. Is Growth Desirable and Sustainable?
A. An antigrowth view exists.
1. Growth causes pollution, global warming, ozone depletion, and other problems.
2. “More” is not always better if it means dead-end jobs, burnout, and alienation from one’s
job.
3. High growth creates high stress.
B. Others argue in defense of growth.
1. Growth leads to an improved standard of living.
2. Growth helps to reduce poverty in poor countries.
3. Growth has improved working conditions.
4. Growth allows more leisure and less alienation from work.
5. Environmental concerns are important, but growth actually has allowed more sensitivity
to environmental concerns and the ability to deal with them.
C. Is growth sustainable? Yes, say proponents of growth.
1. Resource prices are not rising.
2. Growth today has more to do with expansion and application of knowledge and
information, so is limited only by human imagination.
X. LAST WORD: Can Economic Growth Survive Population Decline?
A. The demographic transition is causing greying populations, shrinking labor forces, and
overall population decreases across generations.
1. This is problematic since Real GDP = hours of work x labor productivity.
2. As the working age population declines around the world the ‘hours of work’ will most
likely decline.
3. Living standards are likely to fall as the percentage of the working age population shrinks
relative to the non-working age population.
4. This problem will be exacerbated by social insurance programs around the developed
world.
B. Productivity growth is necessary to sustain economic growth in the future.
1. Tight labor markets might spur economic growth (labor saving technological
improvements).
2. The flip-side of this argument is that with less young people there will be less invention
and innovation.
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Chapter 08 – Economic Growth
QUIZ
1. Which is a demand factor in economic growth?
A. More human and natural resources
B. Technological progress and innovation
C. An increase in the economy’s stock of capital goods
D. An increase in total spending in the economy
2. The entry of women into the workforce since the 1960s resulted in:
A. A shift outward in the production possibilities curve of the United States
B. A shift inward in the production possibilities curve in the United States
C. A movement along the existing production possibilities curve in the United States
D. A falling real wage for women workers of the United States
3. A decline in a nation’s rate of productivity growth will:
A. Reduce the inflation rate
B. Increase education and training
C. Slow the growth of the standard of living
D. Make industry more competitive in world markets
4. If the annual growth in a nation’s productivity is 2.5 percent rather than 1.5 percent, then the
nation’s standard of living will double in about:
A. 20 years
B. 28 years
C. 46 years
D. 56 years
2. Which is best considered a supply factor for long-run economic growth?
A. Government spending
B. The stock of capital goods
C. Full employment of resources
D. Personal consumption expenditures
3. Real GDP per capita:
A. cannot grow more rapidly than real GDP.
B. cannot grow more slowly than real GDP.
C. necessarily grows more rapidly than real GDP.
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Chapter 08 – Economic Growth
D. can grow either more slowly or more rapidly than real GDP.
4. Growth is advantageous to a nation because it:
A. promotes faster population growth.
B. lessens the burden of scarcity.
C. eliminates the economizing problem.
D. slows the growth of wants.
5. Increases in the value of a product to each user, including existing users, as the total number
of users rises are called:
A. information cascades.
B. learning effects.
C. network effects.
D. scale economies.
6. Economists who believe that the recent increase in the average productivity growth rate may
be permanent claim that the above-normal economic growth in the United States between
1995 and 2009 was caused by:
A. increases in the rate of personal saving.
B. increased entrepreneurial activity, application of information technology, and global
competition.
C. rising Federal budget surpluses that reduced real interest rates.
D. expansionary monetary policy.
7. Critics of economic growth:
A. contend that growth and industrialization reduce pollution.
B. argue that economic growth does not resolve socioeconomic problems such as an unequal
distribution of income and wealth.
C. point out that growth results in greater economic security for workers.
D. say that its benefits accrue nearly exclusively to white males.
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