Posted: February 26th, 2023

Principles of Economics

Question 1

Discussion: If you compare the change in GDP to the change in per capita GDP, which would you expect to be larger? Why?

Question 2

Discussion: Some low-income countries and middle-income countries around the world have shown a pattern of economic convergence with high-income countries. What is this? Illustrate with an example.

PRINCIPLES OF ECONOMICS 2e

Chapter 20 Economic Growth

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COLLEGE PHYSICS

Chapter # Chapter Title
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CH.7 OUTLINE
7.1: The Relatively Recent Arrival of Economic
Growth
7.2: Labor Productivity and Economic Growth
7.3: Components of Economic Growth
7.4: Economic Convergence

Average Daily Calorie Consumption

Not only has the number of calories that people consume per day increased, so has the amount of food calories that people are able to afford based on their working wages.
(Credit: modification of work by Lauren Manning/Flickr Creative Commons)

This OpenStax ancillary resource is © Rice University under a CC-BY 4.0 International license; it may be reproduced or modified but must be attributed to OpenStax, Rice University and any changes must be noted. Any images attributed to other sources are similarly available for reproduction, but must be attributed to their sources.

7.1 The Relatively Recent Arrival of
Economic Growth
Modern economic growth – the period of rapid economic growth from 1870 onward.

Rapid and sustained economic growth is a relatively recent experience for the human race.

Before the last two centuries, the average person’s standard of living had not changed much for centuries.

Industrial Revolution

Industrial Revolution – the widespread use of power-driven machinery and the economic and social changes that resulted in the first half of the 1800s.

The Industrial Revolution led to increasing inequality among nations.
1870: GDP of the top economies of the world was 2.4 times the GDP per capita of the world’s poorest economies.
1960: the top economies had 4.2 times the GDP per capita of the world’s poorest economies.

Rule of Law and Economic Growth
Influence of two key factors on an economy’s long-run economic growth:

Adherence to rule of law –
The process of enacting laws that protect individual and entity rights to use their property as they see fit.
Laws must be clear, public, fair, and enforced, and applicable to all members of society.

Protection of contractual rights –
The rights of individuals to enter into agreements with others regarding the use of their property
Providing recourse through the legal system in the event of noncompliance.

7.2 Labor Productivity and
Economic Growth
Sustained long-term economic growth comes from increases in worker productivity.
Labor productivity – the value of what is produced per worker, or per hour worked (sometimes called worker productivity).
Determinants of worker productivity:
Human capital – the accumulated knowledge (from education and experience), skills, and expertise that the average worker in an economy possesses.
Technological change – a combination of invention and innovation.
Invention – advances in knowledge.
Innovation – putting advances in knowledge to use in a new product or service.
Economies of scale – the cost advantages that industries obtain due to size.

Sources of Economic Growth:
The Aggregate Production Function
Production function – the process whereby a firm turns economic inputs like labor, machinery, and raw materials into outputs like goods and services that consumers use.
A microeconomic production function describes a firm’s or an industry’s inputs and outputs.
In macroeconomics, we call the connection from inputs to outputs for the entire economy an aggregate production function.
Aggregate production function – the process whereby an economy as a whole turns economic inputs such as human capital, physical capital, and technology into output measured as GDP per capita.

Components of the Aggregate Production Function

An aggregate production function shows what goes into producing the output for an overall economy.
This aggregate production function has GDP as its output.

This aggregate production function has GDP per capita as its output. Because we calculate it on a per-person basis, we already figure the labor input into the other factors and we do not need to list it separately.

Measuring Productivity
An economy’s rate of productivity growth is closely linked to the growth rate of its GDP per capita.

A common measure of U.S. productivity per worker is the dollar value (output) per hour that the worker contributes to the employer’s output.
This measure excludes government workers and farming.

Output per Hour Worked in the
U.S. Economy, 1947–2011
Output per hour worked is a measure of worker productivity.
In the U.S. economy, worker productivity rose more quickly in the 1960s and the mid-1990s compared with the 1970s and 1980s.
However, these growth-rate differences are only a few percentage points per year.
The average U.S. worker produced over twice as much per hour in 2014 than he did in the early 1970s. (Source: U.S. Department of Labor, Bureau of Labor Statistics.)

Productivity Growth Since 1950
U.S. growth in worker productivity was very high between 1950 and 1970.
It then declined to lower levels in the 1970s and the 1980s.
The late 1990s and early 2000s saw productivity rebound, but then productivity sagged a bit in the 2000s.
Some think the productivity rebound of the late 1990s and early 2000s marks the start of a “new economy” built on higher productivity growth, but we cannot determine this until more time has passed. (Source: U.S. Department of Labor, Bureau of Labor Statistics.)

The Power of Sustained Economic Growth
Nothing is more important for people’s standard of living than sustained economic growth.
Even small changes in the rate of growth, when sustained and compounded over long periods of time, make an enormous difference in the standard of living.
To calculate what GDP will be at the given growth rate in the future:
GDP at starting date × (1 + growth rate of GDP)years = GDP at end date
Examples of growth of GDP over different time horizons:

GDP and Compound Growth Rates
Compound growth rate – the rate of growth when multiplied by a base that includes past GDP growth.

Example: If South Korea had a GDP of $1.67 trillion with a growth rate of 2.8%, we can estimate future GDP’s.

7.3 Components of Economic Growth
Physical capital – the plant and equipment that firms use in production; this includes infrastructure.
Infrastructure – a component of physical capital such as roads and rail systems.
increase in the quantity
increase in the quality

Human capital

Technology – all the ways in which existing inputs produce more or higher quality, as well as different and altogether new products.

Capital Deepening
Capital deepening – when society increases the level of capital per person.

The idea of capital deepening can apply both to additional human capital per worker and to additional physical capital per worker.

Human Capital Deepening in the U.S.
Rising levels of education for persons 25 and older show the deepening of human capital in the U.S. economy.
Today, under one-third of U.S. adults have completed a four-year college degree.
There is clearly room for additional deepening of human capital to occur. (Source: US Department of Education, National Center for Education Statistics)

Physical Capital per Worker in the United States
The value of physical capital, measured by plant and equipment, used by the average worker in the U.S. economy has risen over the decades.
The increase leveled off in the 1970s and 1980s, which were also times of slower-than-usual growth in worker productivity.
We see a renewed increase in physical capital per worker in the late 1990s, followed by a flattening in the early 2000s. (Source: Center for International Comparisons of Production, Income and Prices, University of Pennsylvania)

Growth Accounting Studies
Economists can conduct growth accounting studies to determine the extent to which physical and human capital deepening and technology have contributed to growth.

Technology is typically the most important contributor to U.S. economic growth.
Growth in human capital and physical capital explains only half or less of economic growth.

The three factors of human capital, physical capital, and technology must all be present to succeed.

A Healthy Climate for Economic Growth
Markets that allow personal and business rewards and incentives for increasing human and physical capital encourage overall macroeconomic growth.
There are times when markets fail to allocate capital or technology in a manner that provides the greatest benefit for society as a whole.
Some areas in which governments around the world have chosen to invest in to facilitate capital deepening and technology:
Education
Savings and Investment
Infrastructure
Special Economic Zones – area of a country, usually with access to a port where, among other benefits, the government does not tax trade.
Scientific Research

7.4 Economic Convergence
Convergence – pattern in which economies with low per capita incomes grow faster than economies with high per capita incomes.

(Source: http://databank.worldbank.org/data/views/variableSelection/selectvariables.aspx?source=world-development-indicators#c_u)
Middle-income countries have GDP growth that is faster than that of the low-income countries.
Low-income countries have GDP growth that is faster than that of the high-income countries.

Arguments Favoring Convergence
Low-income countries might have an advantage in achieving greater worker productivity and economic growth in the future.

Diminishing marginal returns: low-income economies could converge to the levels that the high-income countries achieve.

Low-income countries may find it easier to improve their technologies than high-income countries, by applying technology that has already been invented.
Economist Alexander Gerschenkron names this “the advantages of backwardness”.

Low-income countries have observed the experience of those that have grown more quickly and have learned from it.

Arguments That Convergence Is Neither Inevitable nor Likely
Developing new technology can provide a way for an economy to sidestep the diminishing marginal returns of capital deepening.

Will technological improvements run into diminishing returns over time?
Does not seem so because we can apply widely the ideas of new technology at a marginal cost that is very low or even zero.

When it comes to adapting and using new technology, a society’s performance is not necessarily guaranteed.
Low-income countries may have opportunities to copy and adapt technology, but if they lack the appropriate supportive economic infrastructure and institutions, new technologies may not have relevance.

Capital Deepening and New Technology
If the economy relies only on capital deepening, while remaining at the technology level shown by the Technology 1 line, then it would face diminishing marginal returns as it moved from point R to point W.
Now imagine that capital deepening combines with improvements in technology.
As capital deepens, technology also improves from Technology 1 to Technology 2, and the economy moves from R to S.
Similarly, if capital deepens more and technology increases from Technology 2 to Technology 3, then the economy moves from S to T.
With improvements in technology, there is no longer any reason that economic growth must necessarily slow down.

The Slowness of Convergence
Economic convergence between high-income countries and the rest of the world seems possible, but it will proceed slowly.
High-income countries have been building up their advantage in standard of living over decades or even centuries.
Example:
A high-income country with a GDP per capita now of $40,000, with a 2% annual growth rate, after 30 years, will end up with a GDP of $72,450. (= $40,000(1 + 0.02)^30)
While in a poor country with a GDP per capita now of $4,000, with a 7% annual growth rate, after 30 years, will end up with a GDP of $30,450. (= $4,000(1 + 0.07)^30).
Convergence has occurred.
The rich country was 10 times as wealthy as the poor one, and now it is only about 2.4 times as wealthy.
Even after 30 consecutive years of very rapid growth, people in the low-income country are still likely to feel quite poor compared to people in the rich country.

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PRINCIPLES OF ECONOMICS 2e

Chapter 19 The Macroeconomic Perspective

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COLLEGE PHYSICS

Chapter # Chapter Title
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CH.6 OUTLINE
6.1: Measuring the Size of the Economy: Gross
Domestic Product
6.2: Adjusting Nominal Values to Real Values
6.3: Tracking Real GDP over Time
6.4: Comparing GDP among Countries
6.5: How Well GDP Measures the Well-Being of
Society

The Great Depression

At times, such as when many people have trouble making ends meet, it is easy to tell how the economy is doing.
This photograph shows people lined up during the Great Depression, waiting for relief checks.
At other times, when some are doing well and others are not, it is more difficult to ascertain how the economy of a country is doing. (Credit: modification of work by the U.S. Library of Congress/Wikimedia Commons)

Macroeconomic Goals, Framework, and Policies
This chart shows what macroeconomics is about:

Goals – a consensus of what are the most important goals for the macro economy.
Framework – what economists use to analyze macroeconomic changes (such as inflation or recession).
Policy Tools – the tools the federal government uses to influence the macro economy.

6.1 Measuring the Size of the Economy:
Gross Domestic Product
Gross domestic product (GDP) – the value of the output of all final goods and services produced within a country in a given year.
Measures the size of a nation’s overall economy.

An economy’s GDP can be measured by either:
the total dollar value of what consumers purchase in the economy.
the total dollar value of what the country produces.

GDP Measured by Components of Demand
Who buys all of a country’s production?

Demand for production can be divided into four main parts:
consumer spending (consumption)
business spending (investment)
government spending on goods and services
spending on net exports

Percentage of Components of 2016
U.S. GDP on the Demand Side
Consumption makes up over half of the demand side components of the GDP. (Source: http://bea.gov/iTable/index_nipa.cfm)

Components of GDP on the Demand Side
For graph (a):
Consumption is about two-thirds of GDP, but it moves relatively little over time.
Business investment hovers around 15% of GDP, but it increases and declines more than consumption.
Government spending on goods and services is around 20% of GDP.

Components of GDP on the Demand Side, Continued
For graph (b):
Exports are added to total demand for goods and services, while imports are subtracted from total demand.
If exports exceed imports, as in most of the 1960s and 1970s in the U.S. economy, a trade surplus exists.
If imports exceed exports, as in recent years, then a trade deficit exists. (Source: http://bea.gov/iTable/index_nipa.cfm)

Net Export Component
The GDP net export component, or trade balance, is equal to the dollar value of exports (X) minus the dollar value of imports (M).

Trade balance – the gap between exports and imports.
Trade balance = (X – M)

Trade surplus – when a country’s exports are larger than its imports; calculated as exports – imports.

Trade deficit – when a country’s imports exceed exports; calculated as imports – exports.

GDP Using Demand
Based on the four components of demand, GDP can be measured as:

GDP = Consumption + Investment + Government + Trade balance

GDP = C + I + G + (X – M)

GDP Measured by What is Produced
Production can be divided into five main parts:
Durable goods – long-lasting good like a car or a refrigerator.
Nondurable goods – short-lived good like food and clothing.
Services – product which is intangible (in contrast to goods) such as entertainment, healthcare, or education.
Structures – building used as residence, factory, office building, retail store, or for other purposes.
Change in inventories – good that has been produced, but not yet been sold.

Every market transaction must have both a buyer and a seller, so GDP must be the same whether measured by what is demanded or by what is produced.

Percentage of Components of GDP on the Production Side
Services make up over 60 percent of the production side components of GDP in the United States.
Note that the change in inventories is not shown since it is typically less than 1% of GDP.

Types of Production
Services are the largest single component of total supply, representing over 60 percent of GDP, up from about 45 percent in the early 1960s.

Durable and nondurable goods constitute the manufacturing sector, and they have declined from 45 percent of GDP in 1960 to about 30 percent in 2016.

Types of Production, Continued
Nondurable goods used to be larger than durable goods, but in recent years, nondurable goods have been dropping to below the share of durable goods, which is less than 20% of GDP.

Structures hover around 10% of GDP.

The change in inventories is not shown here since it is typically less than 1% of GDP.

The Problem of Double Counting
Final goods and services – output used directly for consumption, investment, government, and trade purposes.
Goods at the furthest stage of production at the end of a year.
-vs.-
Intermediate goods – output provided to other businesses at an intermediate stage of production, not for final users.
Excluded from GDP calculation.

Double counting – output that is counted more than once as it travels through the stages of production.
A potential mistake to avoid in measuring GDP.

GDP is the dollar value of all final goods and services produced in the economy in a year.

Other Ways to Measure the Economy
Gross national product (GNP) – includes what is produced domestically and what is produced by domestic labor and business abroad in a year.

Net national product (NNP) – GNP minus the value of depreciation.

Depreciation – the process by which capital ages over time and therefore loses its value.

NNP can be further subdivided into national income – includes all income earned: wages, profits, rent, and profit income.

6.2 Adjusting Nominal Values to
Real Values
Nominal value – the economic statistic actually announced at that time; not adjusted for inflation.
-vs.-
Real value – an economic statistic after it has been adjusted for inflation.

Generally, the real value is more important.

U.S. Nominal GDP, 1960–2010
Nominal GDP values have risen exponentially from 1960 through 2010, according to the BEA.

GDP Deflator, 1960–2010
The GDP deflator is a price index measuring the average prices of all goods and services included in the economy.

Much like nominal GDP, the GDP deflator has risen exponentially from 1960 through 2010. (Source: BEA)

Calculating Real GDP

Real GDP = Nominal GDP
Price Index / 100

Notes:
Price index is the same as GDP deflator.

For simplicity, the price index is traditionally published after being multiplied by 100 in order to get an integer number.
So, remember to divide the published price index by 100 when doing the math.

Whenever a real statistic is computed, one year (or period) is called the base year (or base period).
The base year is the year whose prices we use to compute the real statistic.

Example: Calculating Real GDP
To calculate the real GDP in 1960:
Real GDP = Nominal GDP
Price Index / 100
= $543.3 billion
19 / 100
= $2,859.5 billion
2005 is the base year.
Question: What will the Real GDP be in 2005? Why?

Example: Calculating Real GDP,
Continued
To calculate the real GDP in 2010:
Real GDP = Nominal GDP
Price Index / 100
= $14,958.3 billion
110 / 100
= $13,598.5 billion
As long as inflation is positive (prices increase on average from year to year) real GDP should be less than nominal GDP in any year after the base year.

U.S. Nominal and Real GDP, 1960–2012
The black line measures U.S. GDP in real dollars, where all dollar values are converted to 2005 dollars.
Since we express real GDP in 2005 dollars, the two lines cross in 2005.
Real GDP will appear higher than nominal GDP in the years before 2005, because dollars were worth less in 2005 than in previous years.
Conversely, real GDP will appear lower in the years after 2005, because dollars were worth more in 2005 than in later years.

Example: Calculating Real GDP
Growth Rate
What was the real GDP growth rate from 1960 to 2010?
2010 real GDP – 1960 real GDP = % change
1960 real GDP × 100

13,598.5 – 2,859.5 = 376%
2,859.5 × 100
The U.S. economy increased real production of goods and services by nearly a factor of four since 1960.

6.3 Tracking Real GDP over Time
Governments report GDP growth as an annualized rate.

When analyzing growth in a quarter, the calculated growth in real GDP for the quarter is multiplied by four when it is reported (as if the economy were growing at that rate for a full year).

Recession – a significant decline in national output/GDP.

Depression – an especially lengthy and deep decline in output.

U.S. GDP, 1900–2016
Real GDP in the United States in 2016 (in 2009 dollars) was about $16.7 trillion.
After adjusting to remove the effects of inflation, this represents a roughly 20-fold increase in the economy’s production of goods and services since the start of the twentieth century. (Source: bea.gov)

Patterns of Recessions and Expansions
Peak – during the business cycle, the highest point of output before a recession begins.

Trough – during the business cycle, the lowest point of output in a recession, before a recovery begins.

A recession lasts from peak to trough, and an economic upswing runs from trough to peak.

Business cycle – the economy’s relatively short-term movement in and out of recession

6.4 Comparing GDP among Countries

To compare the GDP of countries with different currencies, it is necessary to convert to a “common denominator” using an exchange rate.

Exchange rate – the value or price of one currency in terms of another currency.

Example: Converting GDP to a Common Currency
Example: Compare Brazil’s GDP in 2013 of 4.8 trillion reals with the U.S. GDP of $16.6 trillion for the same year.
In 2013, the exchange rate was 2.157 reals = $1.

Convert Brazil’s GDP into U.S. dollars:

Brazil’s GDP in $U.S. = Brazil’s GDP in reals
Exchange rate (reals/$ U.S.)
= 4.845 trillion reals
2.157 reals per $ U.S.
= $2.246 trillion GDP
Compare this value to the GDP in the United States in the same year.
The U.S. GDP was $16.6 trillion in 2013, which is nearly eight times that of GDP in Brazil.

GDP Per Capita
The U.S. economy has the largest GDP in the world, and is also a populous country.

Is its economy also larger on a per-person basis?

GDP per capita – the GDP divided by the population.

GDP per capita = GDP
population

6.5 How Well GDP Measures the
Well-Being of Society
Standard of living – all elements that affect people’s happiness and well-being, whether they are bought and sold in the market or not.

Difference between GDP and standard of living.

GDP does not include:
leisure time
actual levels of environmental cleanliness, health, and learning
production that is not exchanged in the market
the level of inequality in society
what technology and products are available

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