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Economics 1022A/B
Jeannie A Gillmore

Economics – Textbook Notes Chapter 22 – Economic Growth The Basics of Economic Growth Economic growth is a sustained expansion of production possibilities measured as the increase in real GDP over a given period Calculating Growth Rates The economic growth rate is the annual percentage change of real GDP  The growth rate of real GDP tells us how rapidly the total economy is expanding  It does not tell us about changes in the standard of living o The standard of living depends on real GDP per person (also called per capita real GDP) which is real GDP divided by the population o The real GDP per person growth rate is the same equation as above o The growth rate of real GDP per person can also be calculated (approx.) by subtracting the population growth rate from the real GDP growth rate  Real GDP per person grows only if real GDP grows faster than the population The Magic of Sustained Growth  Compound Interest o Rule of 70 states that the number of years it takes for the level of any variable to double is approximately 70 divided by the annual percentage growth rate of the variable  The rule of 70 applies to any variable Economic Growth Trends Real GDP Growth in the World Economy  Even modest differences in economic growth rates sustained over a number of years brings enormous differences in the standard of living How Potential GDP Grows Economic growth is a sustained, year-after-year increase in potential GDP How Potential GDP is Determined  Land capital, labour, and entrepreneurship produce real GDP, and the productivity of the factors of production determines the quantity of real GDP that can be produced o The quantity of labour is the only variable factor of production  Potential GDP is the level of real GDP when the quantity of labour employed is the full-employment quantity  To determine potential GDP, we use a model with two components: o The Aggregate Production Function  The quantity of leisure time is the number of hours spent not working  Each leisure hour could have been spent working  If we spent all our time taking leisure, we would do no work and produce nothing o Real GDP would be zero  The more leisure we forgo, the greater is the quantity of labour and the greater is the quantity of real GDP produced  Labour hours are not all equally productive, we use our most productive hours first and as more hours are worked less and less productive hours are used  Increasing at a decreasing slope  The aggregate production function is the relationship that tell us how real GDP changes as the quantity of labour changes when all other influences on production remain the same o The Aggregate Labour Market  The aggregate labour market determines the quantity of labour hours employed and the quantity of real GDP supplied  Demand for Labour  The relationship between the quantity of labour demanded and the real wage rate  The real wage rate is the money wage rate divided by the price level. It is the quantity of goods and services that an hour of labour earns  Supply of Labour  The supply of labour is the relationship between the quantity of labour supplied and the real wage rate  Labour Market Equilibrium  When there is an equilibrium of real wage rate and level of employment, the economy is at full employment o Potential GDP  At the equilibrium quantity of labour, the economy is at full employment and the quantity of real GDP at full employment is potential GDP  So the full-employment quantity of labour produces potential GDP When Makes Potential GDP Grow? We can divide all the forces that make potential GDP grow into two categories:  Growth of the Supply of Labour o When the supply of labour grows, the supply of labour curve shifts right- wards  The quantity of labour at a given real wage rate increases o The quantity of labour is the number of workers employed multiplied by average hours per worker; and the number employed equals the employment-to-population ratio multiplied by the working-age population o The quantity of labour changes as a result of changes in:  Average hours per worker  The employment-to-population ratio  The working-age population o Effects of Population Growth  Brings growth is the supply of labour, but doesn’t change the demand for labour or the production function  Increased supply  real wage rate falls, quantity of labour increases  More output and potential GDP increases  Growth of Labour Productivity o Labour productivity is the quantity of real GDP produced by an hour of labour  Calculated by dividing real GDP by aggregate labour hours o When labour productivity grows, real GDP per person grows and brings a rising standard of living o Effects of an Increase in Labour Productivity  If labour productivity increases, production possibilities expand  If labour is more productive, firms are willing to pay more for a given number of hours of labour so the demand for labour also increases  Increase in demand for labour, no change in the supply of labour, the real wage rate rises and the quantity of labour supplied increases  Increase in labour productivity increases potential GDP for two reasons: labour is more prod
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