Economic Growth
Chapter 10
Basics of Economic Growth
• How to calculate growth rate
– Growth rate of real GDP = (real GDP in current year –
real GDP in previous yea) / real GDP in previous year *
100
– Growth rate of real GDP per capita = growth rate of
real GDP – growth rate of population
• Rule of 70
– The number of years it takes for the level of any
variable to double is approximately 70 divided by the
annual growth rate of the variable
Sources of Economic Growth
• Sources
– Increase in labor (aggregate hours)
– Physical capital growth
– Human capital growth
– Technology advance
• The last three sources contribute to
economic growth through labor productivity
– Labor productivity = real GDP / aggregate hours
Sources of Economic Growth
Continued
• Productivity curve
– Relationship between labor productivity (real GDP per
hour of labor) and the amount of physical per hour of
labor
– Movement along the productivity curve is caused by
changes in capital per hour of labor.
• One third rule: 1% capital increase 1/3 % labor productivity
– Shift of the productivity curve is caused by changes in
human capital and technological advance.
– Why lower labor productivity growth in the 1970s?
Theories of Economic Growth
• Classical growth theory
– A pessimistic view that an exploding population and
limited resources will eventually bring economic
growth to an end.
– Also called Malthusian theory
– Process
• Initially economic growth from subsistence level with more
capital and technology advance population growth and no
more resources push the economy back to the subsistence level
– Background: population explosion of 18th c. Europe
Theories of Economic Growth
Continued
• Neoclassical growth theory
– Population growth and technology advance will affect
economic growth, but as long as technology keeps
advancing, the economy will grow.
– Technology advance is exogenous (a result of chance).
– Background: no more population explosion in the 19th
and 20th c.
– Shortcoming: no explanation of how technology
advances.
Theories of Economic Growth
Continued
• New growth theory
– Our unlimited wants will lead us to ever greater
productivity and perpetual economic growth.
– Our choices and preference for better living and
profits lead us new discoveries and
accumulation of human capital.
– Competition squeeze profits seeking new
discoveries
– Continuous shift up of the productivity curve
Preconditions for
Economic Growth
• Preconditions: Economic freedom
– Freedom of individuals and businesses from
government restraints on economic activities
– Legal and institutional frameworks to
safeguard economic freedom (such as property
rights and contract laws)
– Visit www.heritage.org for ranking of
individual countries.
Policies to
Achieve Economic Growth
• Create the incentive mechanisms
• Promote competition
• Promote international trade
• Encourage saving
• Encourage investment, particularly R & D.
• Improve quality of education and training