CHAPTER 18

Long-Run Growth

Prepared by: Fernando Quijano

and Yvonn Quijano

© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair
 Long-Run Growth
C H A P T E R 18: Long-Run Growth

• Economic growth refers to an

increase in the total output of an
economy. Defined by some
economists as an increase of real
GDP per capita.

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 Long-Run Growth
C H A P T E R 18: Long-Run Growth

• Modern economic growth is the

period of rapid and sustained
increase in real output per capita that
began in the Western World with the
Industrial Revolution.

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 The Growth Process:
From Agriculture to Industry
C H A P T E R 18: Long-Run Growth

• The production possibility

frontier (ppf) shows all the
combinations of output that
can be produced if all
society’s scarce resources
are fully and efficiently
employed.
• Economic growth expands
society’s production
possibilities, shifting the
ppf up and to the right.

© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 4 of 40
 The Growth Process:
From Agriculture to Industry
C H A P T E R 18: Long-Run Growth

• Before the Industrial Revolution in Great

Britain, every society in the world was
agrarian.

• Beginning in England around 1750,

technical change and capital accumulation
increased productivity in two important
industries: agriculture and textiles.

• More could be produced with fewer

resources, leading to new products, more
output, and wider choice.

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 The Sources of Economic Growth
C H A P T E R 18: Long-Run Growth

• An aggregate production function

is the mathematical representation
of the relationship between inputs
and national output, or gross
domestic product.

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 The Sources of Economic Growth
C H A P T E R 18: Long-Run Growth

• If you think of GDP as a function of

both labor and capital, you can see
that an increase in GDP can come
about through:
1. An increase in the labor supply
2. An increase in physical or human
capital
3. An increase in productivity (the amount
of product produced by each unit of
capital or labor)
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 An Increase in Labor Supply
C H A P T E R 18: Long-Run Growth

• An increasing labor supply can

generate more output, but if the
capital stock remains fixed, the new
labor will be less productive
(diminishing returns).

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 An Increase in Labor Supply
C H A P T E R 18: Long-Run Growth

• Malthus and Ricardo predicted a

gloomy future as population
outstripped the land’s capacity to
produce. However, they forgot the
impact of technological change and
capital accumulation.

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 An Increase in Labor Supply
C H A P T E R 18: Long-Run Growth

• Growth in the labor force, without a

corresponding increase in the
capital stock or technological
change, might lead to growth of
output but declining productivity and
a lower standard of living.

© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 10 of 40
 An Increase in Labor Supply
C H A P T E R 18: Long-Run Growth

Economic Growth from an Increase in Labor – More Output but

Diminishing Returns and Lower Labor Productivity
QUANTITY QUANTITY TOTAL MEASURED
OF LABOR OF CAPITAL OUTPUT LABOR
L K Y PRODUCTIVITY
PERIOD (HOURS) (UNITS) (UNITS) Y/L
1 100 100 300 3.0
2 110 100 320 2.9
3 120 100 339 2.8
4 130 100 357 2.7

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 An Increase in Labor Supply
C H A P T E R 18: Long-Run Growth

• Labor productivity is the output per

worker hour; the amount of output
produced by an average worker in 1
hour.

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 An Increase in Labor Supply
C H A P T E R 18: Long-Run Growth

Employment, Labor Force, and Population Growth, 1947 – 2002

CIVILIAN CIVILIAN
NONINSTITUTIONAL LABOR
POPULATION FORCE
OVER 16 YEARS OLD Number Percentage EMPLOYMENT
(MILLIONS) (Millions) of Population (MILLIONS)
1947 101.8 59.4 58.3 57.0
1960 117.3 69.6 59.3 65.8
1970 137.1 82.8 60.4 78.7
1980 167.7 106.9 63.7 99.3
1990 189.2 125.8 66.5 118.8

2002 214.0 142.5 66.6 134.3

Percentage change, 1947 – 2002 + 110.2 + 139.9 + 135.6

Annual rate + 1.4% +1.6% + 1.6%
Source: Economic Report of the President, 2003, Table B-35.

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 An Increase in Labor Supply
C H A P T E R 18: Long-Run Growth

• As long as the economy and the

capital stock are expanding rapidly
enough, new entrants into the labor
force do not displace other workers.

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 Increases in Physical Capital
C H A P T E R 18: Long-Run Growth

• An increase in the stock of capital

can increase output, even if it is not
accompanied by an increase in the
labor force.

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 Increases in Physical Capital
C H A P T E R 18: Long-Run Growth

Economic Growth from an Increase in Capital – More Output,

Diminishing Returns to Added Capital, Higher Measured Labor
Productivity
QUANTITY QUANTITY TOTAL MEASURED
OF LABOR OF CAPITAL OUTPUT LABOR
L K Y PRODUCTIVITY
PERIOD (HOURS) (UNITS) (UNITS) Y/L
1 100 100 300 3.0
2 100 110 310 3.1
3 100 120 319 3.2
4 100 130 327 3.3

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 Increases in Physical Capital
C H A P T E R 18: Long-Run Growth

• The increase in capital stock is the

difference between gross investment
and depreciation.

• Capital has been increasing faster

than the labor force since 1960.
When capital expands more rapidly
than labor, the ratio of capital to
labor (K/L) increases, and this too is
a source of increasing productivity.

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 Increases in Physical Capital
C H A P T E R 18: Long-Run Growth

Fixed Private Nonresidential Net Capital Stock, 1960 – 2001

(Billions of 1996 Dollars)
EQUIPMENT STRUCTURES
1960 672.7 2,015.7
1970 1,154.8 2,744.2
1980 1,989.8 3,589.1
1990 2,722.5 4,703.5
2001 4,480.0 5,682.5

Percentage change, 1960 – 2001 + 566.0 + 181.9

Annual rate + 4.7% + 2.6%
Source: Survey of Current Business, September 2002, Table 15, p. 37.

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 Increases in Human Capital
C H A P T E R 18: Long-Run Growth

Years of School Completed by People Over 25 Years Old, 1940 – 2000

PERCENTAGE
WITH LESS PERCENTAGE PERCENTAGE
THAN 5 WITH 4 YEARS WITH 4 YEARS
YEARS OF OF HIGH SCHOOL OF COLLEGE
SCHOOL OR MORE OR MORE
1940 13.7 24.5 4.6
1950 11.1 34.3 6.2
1960 8.3 41.1 7.7
1970 5.5 52.3 10.7
1980 3.6 66.5 16.2
1990 NA 77.6 21.3
2000 NA 84.1 25.6
NA = not available.
Source: Statistical Abstract of the United States, 1990, Table 215; and 2002, Table 208.

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 Increases in Productivity
C H A P T E R 18: Long-Run Growth

• Growth that cannot be explained by

increases in the quantity of inputs
can be explained only by an increase
in the productivity of those inputs.

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 Increases in Productivity
C H A P T E R 18: Long-Run Growth

• The productivity of an input is the

amount produced per unit of an
input.

• Factors that affect the productivity of

an input include technological
change, other advances in
knowledge, and economies of scale.

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 Increases in Productivity
C H A P T E R 18: Long-Run Growth

• Technological change affects

productivity in two stages:
• First there is an advance in knowledge,
or an invention.
• Then there is innovation, or the use of
new knowledge to produce a new
product or to produce an existing
product more efficiently.
• There are capital-saving innovations,
and labor-saving innovations.
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 Increases in Productivity
C H A P T E R 18: Long-Run Growth

• External economies of scale are

cost savings that result from
increases in the size of industries.

• Production abatement requirements

divert capital and labor from the
production of measured output,
therefore reducing measured
productivity.

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 Growth and Productivity
in the United States
C H A P T E R 18: Long-Run Growth

Growth of Real GDP in the United States, 1871 – 2000

AVERAGE AVERAGE
GROWTH GROWTH
RATE RATE
PERIOD PER YEAR PERIOD PER YEAR
1871-1889 5.5 1950-1960 3.5

1889-1909 4.0 1960-1970 4.2

1909-1929 2.8 1970-1980 3.2

1929-1940 1.6 1980-1990 3.2

1940-1950 5.6 1990-2000 3.2

Sources: Historical Statistics of the United States: Colonial Times to 1970, Tables F47-70, F98-124; U.S. Department of Commerce, Bureau of
Economic Analysis.

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 Growth and Productivity
in the United States
C H A P T E R 18: Long-Run Growth

Growth of Real GDP in the United States and

Other Countries, 1981 – 1998
AVERAGE
GROWTH RATE
COUNTRY PER YEAR
United States 3.2
Japan 2.3
Germany 2.2
France 2.1
Italy 2.0
United Kingdom 2.6
Canada 3.1
Africa 2.7
Asia (excluding Japan) 7.2
Source: Economic Report of the President, 2002, computed from Table B-112.

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 Sources of Growth in the
U.S. Economy, 1929 – 1982
C H A P T E R 18: Long-Run Growth

Sources of Growth in the United States, 1929 – 1982

PERCENT OF GROWTH ATTRIBUTABLE TO EACH SOURCE
1929 – 1982 1929 – 1948 1948 – 1973 1973 – 1979
Increases in inputs 53 49 45 94
Labor 20 26 14 47
Capital 14 3 16 29
Education (human capital) 19 20 15 18

Increases in productivity 47 51 55 6
Advances in knowledge 31 30 39 8
Other factorsa 16 21 16 2

Annual growth rate 2.8 2.4 3.6 2.6

in real national
income
Economies of scale, weather, pollution abatement, worker safety and health, crime, labor disputes, and so forth.
a

Source: Edward Denison, Trends in American Economic Growth, 1929 – 1982 (Washington: Brookings Institution, 1985).

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 Labor Productivity: 1952 – 2003
C H A P T E R 18: Long-Run Growth

© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 27 of 40
 Labor Productivity: 1952 – 2003
C H A P T E R 18: Long-Run Growth

• Some of the explanations for the

slowdown in productivity growth in
the 1970s include:
• A low rate of saving
• Increased environmental and
government regulations
• Lack of spending in R&D
• High energy costs

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 Labor Productivity: 1952 – 2003
C H A P T E R 18: Long-Run Growth

• Many of these factors turned around

in the 1980s and 1990s, yet
productivity growth remained low.

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 Economic Growth and Public Policy
C H A P T E R 18: Long-Run Growth

• Policy provisions to improve the

quality of education include the new
Education Individual Retirement
Account that allows savings to earn
tax free returns as long as the
balance is used to pay for
educational expenses.

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 Economic Growth and Public Policy
C H A P T E R 18: Long-Run Growth

• Policies to increase the saving rate

include individual retirement
accounts that accumulate earnings
without paying income tax.

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 Economic Growth and Public Policy
C H A P T E R 18: Long-Run Growth

• The amount of capital accumulation

is ultimately constrained by its rate of
saving.

• The tax system and the social

security system in the United States
are biased against saving.

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 Economic Growth and Public Policy
C H A P T E R 18: Long-Run Growth

• Some public finance economists

favor shifting to a system of
consumption taxation rather than
income taxation to reduce the tax
burden on saving.

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 Economic Growth and Public Policy
C H A P T E R 18: Long-Run Growth

• Other public policies to stimulate

economic growth include:
• Policies to stimulate investment

• Policies to increase research and

development
• Reduced regulations

• Industrial policy, or government

involvement in the allocation of capital
across manufacturing sectors.

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 The Progrowth Argument
C H A P T E R 18: Long-Run Growth

• Advocates of growth believe growth

is progress.

• New technologies and production

methods lead to new and better
products. Capital accumulation and
new technology improve the quality
of life.

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 The Progrowth Argument
C H A P T E R 18: Long-Run Growth

• Growth saves the most valuable

commodity—time.

• Growth also improves the quality of

things that yield satisfaction directly.

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 The Progrowth Argument
C H A P T E R 18: Long-Run Growth

• Growth produces jobs and higher

incomes. With higher incomes we
can better afford the sacrifices
needed to help the poor.

• When population growth is not

accompanied by growth in output,
unemployment and poverty increase.

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 The Antigrowth Argument
C H A P T E R 18: Long-Run Growth

• Growth has negative effects on the

quality of life.

• Growth encourages the creation of

artificial needs.
• Consumer sovereignty is the notion
that people are free to choose, and that
things that people do not want will not
sell. “The consumer rules.”

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 The Antigrowth Argument
C H A P T E R 18: Long-Run Growth

• Growth means the rapid depletion of

a finite quantity of resources.

• Growth requires an unfair income

distribution and propagates it.

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 Review Terms and Concepts
C H A P T E R 18: Long-Run Growth

aggregate production function invention

consumer sovereignty labor productivity

economic growth modern economic growth

industrial policy productivity of an input

innovation

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