Economic Growth

1. Slide 1 of 18
Economic Growth
“Economic growth is necessary to keep the promise that each
generation will have the opportunity to become more prosperous than
the preceding one, the popular term for which is 'the American dream.‘”
-Michael Mandelbaum

2. Slide 2 of 18
What is economic growth?
• An increase in real GDP
occurring over some time
period
• An increase in real GDP
per person occurring over
some time period
Note the term REAL. As we
have already learned, this
suggests that growth exceeds
the inflation rate. In other
words, purchasing power is
increasing. We are able to buy
more!
Why do we care:
Because growth lessens the
burdens of scarcity

3. Slide 3 of 18
For centuries, GDP per capita
was unchanged
The primary inputs for
production were land and labor.
Since land was constant, if you
wanted to produce more, you
added more labor.
Therefore, output per person
didn’t really change much.
In fact, economists have
estimated that Real GDP per
person in much of the world was
relatively unchanged during the
entire 300 BC to 1500 AD
period!

4. Slide 4 of 18
The catalyst: Industrialization
Then something happened…
James Watt (1736 - 1819) a
Scottish inventor and engineer
radically altered the steam
engine
This allowed a movement from
production by hand to
production in a factory
It also allowed an easy flow of
inputs and goods
Factories sprang up and people
began to move to cities for
employment

5. Slide 5 of 18
Industrialization spread quickly
Since the technology was born
in the U.K. the economy there
quickly industrialized.
This technology quickly spread
to Western Europe…
…then to its colonies. Note how
each of these “early adopters” is
among the world’s leaders in
GDP per capita.
Japan industrialized in the
1850s.
Asia and Latin America industrialized
beginning in the 1900s. Their per
capita GDP growth has not risen to the
same heights as the more
industrialized nations.
International trade is a key
catalyst for spreading
technology.

6. Slide 6 of 18
However, just because a country is behind
does not mean they cannot catch up!
Our Real GDP growth rate is
typically slower than many other
countries
It is easy to see that the rapidly
developing countries of China,
India, and Brazil could gain on
the U.S.
U.S. GDP growth has averaged
about 1.8% in the last decade.

7. Slide 7 of 18
In fact, the rule of 72s
suggests that they will!
The rule of 72’s states that a variables
approximate doubling time equals 72 divided
by its growth rate.
If US Real GDP grows by around 3% per
year, that means that it will take about 24
years for Real GDP to double.
If China, for example, is able to continue to
grow its economy at 8% per year or more,
then its Real GDP will double every 9 years.
At such a rapid rate, its easy to imagine that
one day China’s economy will overtake the
U.S. as the worlds largest.

8. Slide 8 of 18
Short run versus long run growth
We’ve learned that short run factors
such as a wealth effect can push AD
higher.LRAS
$200b
In that case, we see economic
growth – here Real GDP has
increased from $200b to $250b.
However, this results in an
inflationary gap. This economy is
beyond its long run potential and
unemployment is low.
It won’t take for workers long to
figure this out and start demanding
raises.
P2
SRAS1
AD2
$250b
And if they get them, then employers
will have no choice but to raise
prices…that is inflation!
AD1
“Inflationary Gap”

9. Slide 9 of 18
Long run growth is the ultimate goal
LRAS1
$200b $250b
In order to obtain sustainable long
run growth, the LRAS must shift
outward.
That allows Real GDP growth to
occur without the dangerous affects
of inflation.
History is replete with examples of
rapid long run economic growth.
LRAS2
LRAS3
$300b
Three of these really stand out:
•The Agricultural Revolution (10,000 BC)
•The Industrial Revolution (1750-1850)
•The Information Revolution (1960-now)

10. Slide 10 of 18
What causes long run economic
growth to occur?
There are numerous factors, but two in particular stand out:
Increases in the
quantity of labor
Increases in the
quality of labor

11. Slide 11 of 18
Ingredient #1: Increases in the
quantity of labor
As can be seen in the graph,
the U.S. has added to its
quantity of labor in almost
every year.
In fact, our labor force has
grown from 60 million in
1948 to almost 160 million in
2009!
Labor Force - The total number of people employed or seeking
employment in a country or region. Sometimes called work force.
Source: U.S. Census Bureau.

12. Slide 12 of 18
We are lucky!
Not everyone has a growing
labor force!
In Japan and other places, a
shrinking workforce does not
bode well for future LRAS
growth.
Source: World Bank

13. Slide 13 of 18
Ingredient #2: Increases in
quality of labor
The second ingredient to long run economic
growth is to make existing labor more
productive.
That can be done by offering training, using
better technology, or providing better tools.
My favorite example may be related to
garbage collection. When I was a kid, it took
three employees to collect garbage: one to
drive the truck and two to collect trash.
Today it takes only one in a truck with a claw.
That frees two employees to do something
else…thereby increasing the economy’s
potential.

14. Slide 14 of 18
Increases in quality of labor can be
delivered in a number of ways
Technology
Education and training
Increased capital
Improvements in
efficiency
For example, employees
trained in a new procedure
may produce more or avoid
output reducing errors.
For example, employees
given computers may be
able to process more
transactions or complete
more sales.
For example, employees
given tools, like this 18-
wheeler-may be able to haul
more
For example, employees
allowed to telecommute may
become more productive.

15. Slide 15 of 18
Increases in quality of labor can be
delivered in a number of ways
Technology
Education and training
Increased capital
Improvements in efficiency
In theory, each of these
would lead to greater
productivity
Productivity – a measure of output per unit of input. For example, the number or
value of manufactured goods each employee can produce per hour.

16. Slide 16 of 18
Productivity growth has been volatile
Between 1950 and 1980,
what was called the
“Productivity Paradox”,
productivity growth slowed.
In the
1980’s
something
happened...
…largely
driven by
the
computer…
…allowing
people to start
new businesses
and work from
anywhere.
It is called “the
productivity
miracle” and has
significantly added
to our economic
growth.
Is it ending? Only
time will tell…
It seemed that each year,
the growth in U.S.
productivity was a little
slower than the last.
Economists worried. With
productivity being a big
ingredient in economic
growth, what if it continued
to slow?!
This axis measures productivity…how much
more can the average worker make this year
versus last year. In 1948, workers were about
3% more “productive”.

17. Slide 17 of 18
Let’s compare these ingredients
with economic growth.
Ingredient #1 is the quantity of
labor.
The U.S. labor force grows by
about 1.7% a year.
History shows the importance of
these two ingredients
Let’s add ingredient #2 – the
quality of labor.
Our productivity sometimes grows
sometimes shrinks. Here it is
added to labor force growth.
Compare, our real GDP growth rate
(in green) with the combination of
population growth and productivity
growth.
It is not a perfect fit…but it is close.
Clearly, these two factors – quantity of labor
(labor force)
and quality of labor (productivity) have a big
influence on economic growth!

18. Slide 18 of 18
In Summary
Economic growth refers to either growth
in Real GDP or Real GDP Per Capita.
We want economic growth because it
lessens the burdens of scarcity.
Many factors lead to economic growth
but two in particular stand out:
Increases in the quantity of labor and
increases in the quality of labor
Ideally, a country would experience both,
thereby enjoying steady economic
growth!