Economic growth, productivity, and living standards

Economic Growth, productivity and Living Standards

  • Most important issue in macroeconomics: long run economic growth the resulting changes in standard of living

Purchasing Power Parity (PPP)

  • Need to convert currencies when comparing GDPs across countries. Can compute exchange rates by comparing the relative prices of similar goods e.g. what is the cost of a Big Mac in London vs New York. PPP exchange rate for this good would be: 1.00=£Price of burger in LondonPrice of burger in NY1.00 = £ \frac{\text{Price of burger in London}}{\text{Price of burger in NY}}
  • PPP is the rate a currency from one country would be to be converted to buy the same market basket of goods in services in another country
  • Difference between PPP value and the actual exchange reveals how currencies are under or over valued relative to each other Actual ratePPP ratePPP rate\frac{\text{Actual rate} - \text{PPP rate}}{\text{PPP rate}}

Simple Interest

Simple interest is interest accumulated only on the principle at each accumulation period:

  • $100 with simple interest rate of 4%
  • Year 1: $100 + 4% of $100 = $100 + $4 = $104
  • Year 2: $104 + 4% of $100 = $104 + $4 = $108

Simple rate, amount accumulated after tt years (or accumulation periods): N=P(1+γt)N = P(1+\gamma t). In other words, the amount accumulated is over tt years is γt\gamma t% of your principle.

Compound Interest

Compound interest is simple interest but at each accumulation period interest is computed with the previously accumulated amount (i.e. earning interest on earned interest)

  • $100 with simple interest rate of 4%
  • Year 1: $100 + 4% of $100 = $100 + $4 = $104
  • Year 2: $104 + 4% of $104 = $104(1+0.04) = $108.16

Compound rate: N=P(1+γ)tN = P(1+\gamma)^t

Rule of 70

How long does it take for the per capita real GDP to double? Can use the rule of 70 (or 72 because it has more commonly used factors): 2P=P(1+r)t    2=(1+r)t    t=log(2)log(1+r)0.693r \begin{aligned} & 2P = P(1+r)^t \\ \implies & 2 = (1+r)^t \\ \implies & t = \frac{\log(2)}{\log(1+r)} \approx \frac{0.693}{r} \\ \end{aligned}

Average Labor Productivity

Economic growth rates measured by annual percentage change in per capita real GDP: Per capita real GDP=YP=YN×NP\text{Per capita real GDP} = \frac{Y}{P} = \frac{Y}{N} \times \frac{N}{P} where YY is real GDP, NN is the number of people employed, PP is the total population. This expansion shows that the product of average labor productivity Y/NY/N and fraction of population that’s employed N/POPN/POP is the per capita real GDP, or average economic output for all people in the population. Can also just look at this as a weighted sum, where the term is the weighted part of those contributing to GDP, and the weight for the remainder of the population is zero, as they contribute nothing due to unemployment.

Understanding Growth

  • LFPR amoung young adults falling due to staying in school longer, decline in unskilled workers
  • In the long run, increases in output per person (and thus living standards) arise primarily from increases in average labor productivity

Determinants of Average Labor Productivity

1. Human Capital

  • Talents, education, training, and skills of workers raise productivity

2. Physical capital

  • Worker productivity depends on tools/machines (physical capital) they work with
  • Subject to diminish returns: with labor and other inputs held constant, then greater amounts of physical capital in use yield less output per additional unit of capital
    • This is because additional unit of capital will be assigned to less productive use that previous units (under the principle of low hanging fruit, or increasing opportunity cost)

3. Land and other natural resources

  • Abundance of valuable natural resources can raise productivity, but not necessarily a very important factor in labor productivity (Nigeria poor with large oil deposits)

4. Technology

  • Most important factor in determining ALP
  • New technology can expand productivity across sectors (think railroad, refridgerated transport, cell phones)
    • Growth seen in industries producing these technologies and those that make use of them
  • Slow productivity in 1973-95 still somewhat unexplained; slow despite first microprocessor in 1971
    • Economic development can lag behind tech breakthroughs
    • New tech may not yield benefits when used in old ways
  • Slowdown after 2000: slowed to 1.5% in 2000-2007, then to 1% in 2007-2016
    • Could be result from dot com collapse of 2000 and following recession in 2001
    • 2007-2009 recession

5. Entrepreneurship and management

  • Productivity of workers depends on those managin what to produce (entrepreneurs)
  • Depends on factors influencing entrepreneural risk like taxation and regulation
  • Management can implement more efficient methods of production

Costs of Economic Growth

  • It’s the cost of creating new capital, which implies
    • cost of saving more and consuming less
    • reduced leisure time and safety
    • cost of R&D
    • cost of education and training

Govt Promoting Econ Growth

  • By supporting and subsidizing education and training programs
    • Positive externalites: informed votes better, higher change of tech innovations
  • Supporting policies that promote savings (retirement)
  • Supporting policies that promote research
  • Stable political framework

Limits to Growth

  • Can growth be sustained in our finite world with finite resource?
  • Discussions often overlook ability of markets to deal with scarcity
  • Also overlook the fact that growth increases society’s capacity to safeguard the environment
  • Note: middle income economies are worst affected by cost of growth: poisted to grow rapidly but not rich enough to be clean while doing so
    • These economies worst impacted by air pollution, for example