Economic Growth I: Capital Accumulation and Population Growth

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The question of growth is nothing new but a new disguise for an age-old issue, one which has always intrigued and preoccupied economics: the present versus the future.

— James Tobin

If you have ever spoken with your grandparents about what their lives were like when they were young, most likely you learned an important lesson about economic growth: material standards of living have improved substantially over time for most families in most countries. This advance comes from rising incomes, which have allowed people to consume greater quantities of goods and services.

To measure economic growth, economists use data on gross domestic product, which measures the total income of everyone in the economy. The real GDP of Canada in 2012 was 7.8 times its 1950 level, and real GDP per person was 4.4 times its 1950 level. In any given year, we can also observe large differences in the standard of living among countries. Table 7-1 shows income per person in 2010 of the world’s 14 most populous countries. The United States tops the list with an income of $47,140 per person. Bangladesh has an income per person of only $640—less than 2 percent of the figure for the United States.

Our goal in this chapter and the next is to understand what causes these differences in income over time and across countries. In Chapter 3 we identified the factors of production—capital and labour—and the production technology as the sources of the economy’s output and, thus, of its total income. Differences in income, then, must come from differences in capital, labour, and technology.

Our primary task in this chapter and the next is to develop a theory of economic growth in per-capita income called the Solow growth model. Our analysis in Chapter 3 enabled us to describe how the economy produces and uses its output at one point in time. The analysis was static—a snapshot of the economy. To explain why our national income grows, and why some economies grow faster than others, we must broaden our analysis so that it describes changes in the economy over time. By developing such a model, we make our analysis dynamic—more like a movie than a photograph. The Solow growth model shows how saving, population growth, and technological progress affect the level of an economy’s output and its growth over time. In this chapter we analyze the roles of saving and population growth. In the next chapter we introduce technological progress.¹