MODULE 2: ECONOMIC GROWTH AND DEVELOPMENT

Short run versus long run growth

 We’ve learned that short run factors such as a wealth effect can push AD higher.
 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.
 And if they get them, then employers will have no choice but to raise prices…that
is inflation! AD1 “Inflationary Gap”
-if people have more income and they have more wealth then they can buy more
products.
-inflationary gap meaning the economy is beyond its long run potential.
-workers will start demanding increase of the minimum wage.
-short-run growth = less thaqn 6 months’ time period.
-factior of production is fixed like income

Long run growth is the ultimate goal

- All factors of production are variable.
- A firm for example can build a bigger factory or a firm can expand its
building/warehouse.
- Time period: 4 – 6 months or even a year.
- Increase in national output and national income. (economic growth)
- FACTORS OF ECONOMIC GROWTH:
- Increase in aggregate demand
- Consumption +government spending+ export - import
- HIGHER REAL WAGES WILL INCREASE CONSUMPTION
- DEVALUATION WILL INCREASE EXPORTS WILL DECREASE IMPORTS
BECAUSE IF YOU ARE EXPORTING YOU GET PAYED
- Increase in government spending
- Lower in interest rate
- Increase in aggregate supply
- Long-run aggregate supply
- Increased investment
- Higher labor productivity
- Discover raw materials
- Increase labor force
- Improve technology
 In order to obtain sustainable long run growth, the LRAS must shift outward.
  That allows Real GDP growth to occur without the dangerous effects of inflation.
 History is replete with examples of rapid long run economic growth.
Three of these really stand out:
•The Agricultural Revolution (10,000 BC)
•The Industrial Revolution (1750-1850)
•The Information Revolution (1960-now)
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
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.
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
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.
1 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.

Inflation is the increase of the prices of goods and services. If prices are too high
consumers will buy less.
If demand is low because of the inflation then the business sector. Inflation distorts
business decisions.
Tax levels:
Products increase prices because of taxes. Interest rates will also impact then
economy.
Inflation adjusted measures that reflects the value of goods and services produced in an
economy in a given year.