Chapter 8 - Economic Growth

CHAPTER EIGHT
CHAPTER 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 the 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 economic growth are given.
1. It is the increase in real GDP, which occurs over a period of time.
2. It is 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 2015 GDP was $10,983
billion compared to Denmark’s $295 billion, but per capita GDP’s were $8,211 and $64,186
respectively.
3. With 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.
E. The growth record of the United States (Table 28.1) is impressive.
1. Real GDP has increased over sixfold since 1950, and real per capita GDP has risen over
threefold (see columns 2 and 4, Table 28.1).
2. Rate of growth record shows that real GDP has grown about 3.1 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.

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Chapter 8 - Economic Growth

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 1800s before spreading to
the Untied States, Canada, and Australia by the mid 1800s.
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. Small differences in the growth rate
matter over long periods of time. If two countries have the same level of per capita income
today, but country 1 grows at 1 percent and country 2 grows at 2 percent, then country 2 will
have twice the per capita income of country 1 seventy years from now.
A. Institutional Structures That Promote Modern Economic GrowthTable 8.2 demonstrates that
poorer follower countries can catch up. But how does a country start that process?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
IV. 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
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.
V. Production Possibilities Analysis (Figure 8.2)

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Chapter 8 - Economic Growth

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).
VI. Accounting for Growth (an attempt to quantify factors contributing to economic growth)
A. More labor input is one source of growth. The labor force has grown by 1.5 million workers per
year for the past 62 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 to1993,
but was responsible for all of it from 2007 to 2015, and is expected to account for about 88
percent of the growth between 2015 and 2026.
1. Consider This . . . Women, the Labor Force, and Economic GrowthThe 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.
C. Technological advance, the most important factor in productivity growth, accounts for 40 percent
of productivity growth.
D. Increases in quantity of capital are estimated to explain about 30 percent of productivity growth.
E. Education and training improve the quality of labor and account for about 15 percent of
productivity growth (see Figure 8.4).
F. Improved resource allocation and economies of scale also contribute to growth and explain about
15 percent 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.
VII. Recent Fluctuations 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 United States experienced a resurgence of productivity growth based on innovations in
computers and communications, coupled with global capitalism. Between 1995 and 2010
productivity growth averaged 2.6 percent annually—up from 1.5 percent over the 1973–1995
period. The “rule of 70” projected real income would double in 24 years rather than 50 years.
C. Much of the improvement in productivity was 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.

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Chapter 8 - Economic Growth

b. Economies of scale and increasing returns in new firms encourage rapid growth.
c. Sources of increasing returns include:More specialized inputs.
d. Ability to spread development costs over large output quantities since marginal costs
are low.
e. Simultaneous consumption by many customers at the same time.
f. Network effects make widespread use of information goods more valuable as more
use the products.
g. Learning increases with practice.
3. Global competition encourages innovation and efficiency.
D. Even if average growth rates in productivity and real output remained higher over time, business
cycle fluctuations (i.e., recessions) can still occur.
E. Following the Great Recession, labor productivity grew at the much slower rate of 0.4 percent.
F. The decrease in productivity growth might be the result of a slowdown in productive new
technologies and/or the implementation of new technologies by businesses.
G. Here are some other potential reasons for the productivity slowdown following the Great
Recession.
1. High debt levels reduce the individuals’ and firms’ willingness to spend on new investment
projects.
2. Prior to the Great Recession, firms invested too much on increasing capacity.
3. Recent products may not add much to GDP because they are free to the user, such as
Facebook, YouTube, etc. However, they still add value to society. Under this hypothesis
things aren't as bad as they seem.
VIII. 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, according to 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 it is limited only by human imagination.
IX. 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 × labor productivity.

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Chapter 8 - Economic Growth

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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