Textbook Notes (362,734)
Canada (158,032)
Economics (380)
ECO100Y5 (285)
Chapter 26

Chapter 26- Long Run Economic Growth.docx

5 Pages
Unlock Document

University of Toronto Mississauga
Kalina Staub

Chapter 26- Long Run Economic Growth 26.1 The Nature of Economic Growth • Economic Growth- Sustained, long-run increases in the level of real GDP • Three variables in economy: Real GDP, Real per capital GDP, and Real GDP per worker • Small differences in income growth rates make enormous differences in levels of income over a few decades • Rule of 72= 72/annual growth rate time it will take for growth rate to double Benefits of Economic Growth • Rising Average Living Standards  Economic growth that raises average income tends to change the whole society’s consumption patterns, shifting away from tangible goods such as TVs and furniture and cars toward services such as vacations, restaurant meals, and financial services  Economic growth provides the higher income that often lead to a demand for a cleaner environment, thus leading to higher average living standards that are not directly captured by measures of per capital GDP • Addressing Poverty and Income Inequality  Rapid growth rate makes alleviation of poverty and the reduction of income inequality easer to achieve politically  If existing income is to be redistributed through the government’s tax or spending policies, someone’s standard of living will actually have to be lowered  However, when there is economy growth and when some of the increment in income is redistributed (through active government policy), it is possible to reduce income inequalities while allowing all incomes to rise Costs of Economic Growth • Foregone Consumption  Economic growth, which promises more g/s tomorrow, is achieved by consuming fewer goods today; this sacrifice of current consumption is an important cost of growth • Social Costs  The process of economic growth reduces machines absolete and also leaves the skills of some workers absolete  A high growth rate requires rapid adjustments in the labour force, which can cause much upset and misery to some people affected by it (lost jobs or lowered incomes) Sources of Economic Growth 1. Growth in the labour force  Growth in population of increases in fraction of population that choose to participate in labour force 2. Growth in human capital  Human Capital- The set of skills workers acquire through formal education and on the job training (quality of the labour force) 3. Growth in physical capital  Factories, machines, electronic equipment, etc (improvements in the quality of physical capital) 4. Technological improvement  Innovation of new products, new ways of producing existing products, and new forms of organizing economic activity 26.2 Established Theories of Economic  Growth A Long Run Analysis  • In the short run macro model, real GDP varies to determine equilibrium, in which desired saving equals desired investment; in the model’s long run version, real GDP is equal to Y* and interest rate varies to determine equilibrium A Theory of Investment, Saving, and Growth  • For a given level of real GDP in the long run (Y*), an increase in household consumption or government purchases must imply a reduction in national saving • National saving (NS) curve is upward sloping supply curve because an increase in the interest rate is assumed to lead households to reduce their current consumption, specially on big ticket items and durable goods that are often purchased on credit • National Saving (NS) curve is steep because household consumption responds only modestly to changes in the real interest rate • Downward sloping investment demand curve because all components of desired investment are negatively related to the real interest rate because whether the investment is financed by borrowing or by using the firm’s retained earnings, the real interest rate reflects the opportunity cost of using these funds • Supply curve for national savings and investment demand curve make up the economy’s market for financial capital • In the long run version of macro model, with real GDP = Y*, the equilibrium interest rate is determined where desired national saving = desired investment • An increase in the Supply of National Saving  An increase in supply of national savings results either because: o Household consumption falls o Government purchases fall (or because T rises, which reduces C)  In the long run, an increase in the supply of national saving reduces the real interest rate and encourages more investment; the higher rate of investment leads to a higher future growth rate of potential output • An Increase in Investment Demand  Increase in demand for investment results from: o Technological improvements that increase the productivity of investment goods o Government tax incentive aimed at encouraging investment  In the long run, an increase in the demand for investment pushes up the real interest rate and encourages more saving by households; the higher rate of saving (and investment) leads to a higher future growth rate of potential output • Investment and Growth in Industrialized Countries  Positive relationship between investment rates and growth rates Neoclassical Growth Theory  • Aggregate Production Function- The relationship between the total amount of each factor of production employed in the nation and the nation’s total GDP • GDP = FT (L, K, H)  Total amounts of labour (L), physical capital (K), quality of labour’s human capital (H), and the state of technology (T)  FT tells us how much GDP will be produced for given amounts of labour and physical capital employed, given levels of human capital, and given state of technology • Properties of the Aggregate Production Function 1. Diminishing Marginal Returns  Law of Diminishing Marginal Returns- The hypothesis that if increasing quantities of a variable factor are applied to a given quantity of fixed factors, the marginal product of the variable factor will eventually decrease  According to the law of diminishing marginal returns, whenever equal increases of one factor of production are combined w
More Less

Related notes for ECO100Y5

Log In


Don't have an account?

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.