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Chapter 22

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ECON 1010
Jean Adams

Chapter 22: Economic Growth ECON 1010 Week 12 • Increase in real GDP per person brings improvement in standard of living • Economic growth: sustained expansion of production possibilities measured as the increase in real GDP over a given period • Rapid economic growth has transformed poor nations into rich ones, e.g. Hong Kong & South Korea • Slow economic growth can result in devastating poverty, e.g. Somalia, Zambia • Economic growth calculation: change in real GDP o [(Real GDP current – Real GDP previous year)/Real GDP in previous year] x 100% o Growth rate tells us how fast the total economy is expanding o Standard of living depends on real GDP per person o Real GDP per person growth rate = same formula as above with real GDP being replaced by real GDP per person o Approx. growth of real GDP per person = real GDP growth rate – population growth rate • Economic growth acts like compound interest in that sustained growth occurs on top of growth • Rule of 70:Avariable doubles in a period of 70/% of growth years • The long-term growth rate varies with time • How Potential GDP Grows: o Economic growth is a sustained growth in potential GDP o Labour, capital, land and entrepreneurship produce real GDP and their productivity determines quantity of real GDP that can be produced o Quantity of land is fixed, as are entrepreneurial ability and capital; quantity of labour employed is the only variable factor o Therefore, potential GDP is the level of GDP when the quantity of labour employed is the full-employment quantity o To determine potential GDP, we use:  An aggregate production function • The PPF for real GDP and the quantity of leisure time • The marginal labour for each increase hour of labour provided decreases over time • APF: Relationship that tells us how real GDP changes as the quantity of labour changes when all other influences on production stay the same • Increase in quantity of labour brings a movement along the production function and an increase in real GDP  An aggregate labour market • To determine this function, the demand and supply for labour as well as labour market equilibrium is studied • The above quantities depend on the real wage rate (price of labour) • Real wage rate: Money wage rate divided by the price level. Quantity of goods and services that an hour of labour earns. • Demand for labour: o Real wage rate influences the quantity of labour demanded because firms pay wages based on the output they must sell to earn the money for wages o Quantity lf labour demanded increases as the real wage rate decreases because of diminishing returns on production firms can only hire if wage rates fall to meet falling output prices • Supply of labour: o Relationship between the quantity of labour supplied and the real wage rate o Quantity of labour supplied is all hours of labour that all households in the economy plan to work o Real wage rate influences quantity of labour supplied because people are able to buy more goods and services with their money • Labour market equilibrium: o Price of labour is the real wage rate and is only minutely affected by labour shortage or surplus o When there is no shortage or surplus of labour, the labour market is in equilibrium o At labour market equilibrium full employment occurs  Therefore, using the labour market equilibrium in combination with the APF PPF, we can determine potential GDP • What makes potential GDP grow? o Growth of the supply of labour  Growth in the supply of labour shifts the labour curve rightward, thus increasing the quantity of labour at any given wage rate  Qlabour = Employment xAverage hours worked  Quantity of labour changes as a result of: • Average hours per worker • Employment-to-population ratio • Working-age population  Traditionally, growth in supply of labour has come from growth in working-age population  Effects of population growth: • Growth in supply of labour • Does not change demand for labour • Economy can produce more output but there is no change in quantity of GDP that quantity of labour can produce • Real wage rate falls without increase in demand and equilibrium quantity of labour increases • Increased quantity of labour produces more output and potential GDP increases o Growth of labour productivity  Labour productivity is the quantity of real GDP produced by an hour of labour  = real GDP/Aggregate abour hours  When labour productivity grows, real GDP grows  Effects of an increase in labour productivity: • Shifts the PPF curve upward because of greater output per hour • More productive labour also increases demand for labour • Real wage rate rises if there is no change in supply of labour and equilibrium quantity increases • Increase in labour productivity increases potential GDP because: o Labour is more productive o More labour is employed • Why Labour Productivity Grows: o Preconditions:  Incentive system created by firms, markets, property rights, and money; enable people to gain by specializing and trading o With preconditions in place, three things influence
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