SECTION 7 Review

Module 37

1. Economic growth is a sustained increase in the productive capacity of an economy and can be measured as changes in real GDP per capita. This measurement eliminates the effects of changes in both the price level and population size. Levels of real GDP per capita vary greatly around the world: more than half of the world’s population lives in countries that are still poorer than the United States was in 1910.

2. Growth rates of real GDP per capita also vary widely. According to the Rule of 70, the number of years it takes for real GDP per capita to double is equal to 70 divided by the annual growth rate of real GDP per capita.

3. The key to long-run economic growth is rising labor productivity, or just productivity, which is output per worker. Increases in productivity arise from increases in physical capital per worker and human capital per worker as well as advances in technology.

Module 38

4. The aggregate production function shows how real GDP per worker depends on physical capital per worker, human capital per worker, and technology. Other things equal, there are diminishing returns to physical capital: holding human capital per worker and technology fixed, each successive addition to physical capital per worker yields a smaller increase in productivity than the one before. Similarly, there are diminishing returns to human capital among other inputs. With growth accounting, which involves estimates of each factor’s contribution to economic growth, economists have shown that rising total factor productivity, the amount of output produced from a given amount of factor inputs, is key to long-run growth. Rising total factor productivity is usually interpreted as the effect of technological progress. In most countries, natural resources are a less significant source of productivity growth today than in earlier times.

5. The world economy contains examples of success and failure in the effort to achieve long-run economic growth. East Asian economies have done many things right and achieved very high growth rates. In Latin America, where some important conditions are lacking, growth has generally been disappointing. In Africa, real GDP per capita declined for several decades, although there are recent signs of progress. The growth rates of economically advanced countries have converged, but the growth rates of countries across the world have not. This has led economists to believe that the convergence hypothesis fits the data only when factors that affect growth, such as education, infrastructure, and favorable policies and institutions, are held equal across countries.

Module 39

6. The large differences in countries’ growth rates are largely due to differences in their rates of accumulation of physical and human capital, as well as differences in technological progress. A prime factor is differences in savings and investment rates, since most countries that have high investment in physical capital finance it by high domestic savings. Technological progress is largely a result of research and development, or R&D.

7. Government actions that contribute to growth include the building of infrastructure, particularly for transportation and public health; the creation and regulation of a well-functioning banking system that channels savings into investment spending; and the financing of both education and R&D. Government actions that slow growth are corruption, political instability, excessive government intervention, and the neglect or violation of property rights.

8. In regard to making economic growth sustainable, economists generally believe that environmental degradation poses a greater problem than natural resource scarcity does. Addressing environmental degradation requires effective governmental intervention, but the problem of natural resource scarcity is often well handled by the incentives created by market prices.

9. The emission of greenhouse gases is clearly linked to growth, and limiting emissions will require some reduction in growth. However, the best available estimates suggest that a large reduction in emissions would require only a modest reduction in the growth rate.

10. There is broad consensus that government action to address climate change and greenhouse gases should be in the form of market-based incentives, like a carbon tax or a cap and trade system. It will also require rich and poor countries to come to some agreement on how the cost of emissions reductions will be shared.

Module 40

11. Long-run economic growth can be analyzed using the production possibilities curve and the aggregate demand–aggregate supply model. In these models, long-run economic growth is represented by an outward shift of the production possibilities curve and a rightward shift of the long-run aggregate supply curve.

12. Physical capital depreciates with use. Therefore, over time, the production possibilities curve will shift inward and the long-run aggregate supply curve will shift to the left if the stock of capital is not replaced.