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ECO102H1 (155)

chapter 26

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Michael Ho

Chapter 26: long-run economic growth 26.1 The nature of economic growth The aspect of economic growth is annual growth rate, the index of real per capital GDP and measure of productivity which is the index of real GDP per employed worker. Though real GDP is an accepted measure of the amount of the annual economic activity, it is not a good measure of average material living standards because it does not take into account the growth in the populationmore income is not necessarily better if more people have to share it. Economic growth: sustained long-run increases in the level of real GDP. Benefits of Economic Growth Rising average living standards Economic growth is a powerful means of improving average material living standards A family often fines that an increase in its income can lead to changes in the pattern of its consumptionextra money buys important amenities of life and also allows more saving for the future. Similarly, growth that raises average income tends to change the whole societys consumption pattern, shifting away from tangible goods and toward services. Another example of how economic growth can improve living standards involves environmental protection. Economic growth provides higher incomes that often lead to a demand for a cleaner environment, therefore leading higher average living standards that are not directly captured by measures of per capital GDP. Alleviation of poverty: Many of the poorest member of the population are not the event in the labor force and hence are unlikely to share in the higher wages that, along with profits, are the primary means by which the gains from the growth is distributed. For this reason, even in growing economy redistribution policies will be needed if poverty is to be reduced. When there is economic growth and when some of the increment in income is redistributed through active government policy, it is possible to reduce income inequalities while simultaneously allowing all incomes to rise. It is much easier for a rapidly growing economy to be generous to word its less fortunate citizens or neighbors then it is for a static economy Costs of economic growth The opportunity cost of economic growth: Economic growth requires heavy investment of resources and capital goods, as well as in such activities as education. Often these investments yield no intermediate return in terms of goods and services for consumption; therefore, they imply the sacrifices are being made by the current generation of consumers. Economic growth, which promises more goods and services tomorrow, is achieved by consuming fewer goods today. For the economy as a whole, this sacrifice of current consumption is the primary cost of growth. Social costs of economic growth One aspect of growing economy is accounted by existing firms expanding and producing more outputs, hiring more workers, and using more equipments and intermediate goods. Another aspect of growth is that existing firms are overtaken made obsolete by new firms, old products are made obsolete by new products, and existing skills are made obsolete by new skills. The process of economic growth renders some machines obsolete and also leaves the skills of some workers partly obsolete. A high growth rate usually requires rapid adjustment in the labour force, which can cause much upset and misery to some of the people affected by it. Sources of economic growth Economic growth has 4 fundamental determinants: 1. Growth in the labour force: this may be caused by growth in population or increase in the fraction of population that chooses to participate in the labour force. 2. Growth in human capital: Human capital is the set of skills workers acquire through formal education and on the job training. Human capital can be thought of as the quality of the labour force, but because of its importance we will treat it as a separate factor of production from labour. 3. Growth in physical capital: the stock of physical capital such as factories, machines electronic equipments, and transportation and communication facilities, increases only through the process of investment. We include here improvements in the quality of the physical capital. 4. Technological improvement: this is brought about the innovation that introduces new products, new ways of producing existing products, and new forms of organizing economic activity. 26.2 established theories of economic growth Focus on the long-run The theory of economic growth is a long-run theory. It concentrates on the growth of potential output (Y*) over long periods of time, not on short-run fluctuations of output around potential. The equilibrium level of real GDP in that model was such that real GDP was equal to desired aggregate expenditure which in the simplest form was equal to desire consumption and desired expenditure: Y = C + I We can re arrange saying that Y-C=I so S=I meaning that saving equals to desired investments. Therefore, taking the real interest as given in our short-run model, the condition that desired saving equal to desired investment determined the equilibrium level of real GDP. In the long run, real GDP is equal to Y*, we can use the saving/investment equilibrium condition by turning it on its head. That is we can take the level of output as given (at Y*) and use the condition that desired saving equals desired investment to determine the equilibrium real interest rate. Investment, saving and growth The complicated model of Real GDP is the addition of government purchases of goods and services (G) and collects taxes (T). National savings is the sum of the private saving and public (government) saving. Desired private saving is the difference between disposable income and desired consumption. With real GDP equal to Y* in the long run, desired private saving is equal to : private saving= Y*= T C Public savings is equal to the combines budget surpluses of the federal, provincial and municipal government: Public saving= T - C National saving is therefore equal to : NS=Y*-T-C+(T-G) NS= Y* - C G For a given level of output in the l
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