Econ 105 Principles of Macroeconomics

Chapter 25 Spring 2022

Reading: Chapter 25 (Macroeconomics/Ragan- 16th edition) page 608 to 620

Chapter 25: Long-Run Economic Growth

Objective: • The four fundamental determinants of growth in real GDP.
• The main element of neoclassical growth theory.

1. The Nature of Economic Growth

Benefits of Economic Growth

• Rising average material living standards

• Alleviation of Poverty and income inequality

Many do not share incomes directly in the growth, but

___________________ of income is politically easier in a growing
economy, but not in a static economy.

Costs of Economic Growth

• Forgone Current Consumption

Economic growth is often encouraged by increasing investment, backed

by higher ____________ today: this requires less consumption today. ➔
the opportunity cost of LR growth.

• Social Costs

Growth usually involves the replacement of some firms and workers: this
process involves real _________________ costs.
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Econ 105 Principles of Macroeconomics
Chapter 25 Spring 2022

Sources of Long Run Economic Growth

The four fundamental sources of long run economic growth are:

• Growth in the labour force

• Growth in __________________________

• Growth in __________________________

• Technological improvements

2. Theories of Long-Run Economic Growth

Focus on the Long Run

We focus on the long run when actual GDP __________ potential output.

We hold Y* constant and let the real interest rate be determined

endogenously by national savings and desired investment.

Investment, Saving and Growth

Desired Investment (= I)

Assuming net investment is positive, the higher investment rate

increases the ________ of capital accumulation that results in a higher
growth rate of potential GDP (Y*) over time. However, the desired
investment demands loanable funds today.

The desired investment represents a demand for loanable funds per

period.
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Econ 105 Principles of Macroeconomics
Chapter 25 Spring 2022

National Saving (=NS)

Desired private savings: the difference between YD and

_______________________.

Public savings: savings made by the government, equal to

________________________.

National savings = Desired private savings + Public savings

NS = (YD - C) + (T – G) =Y* - T - C + (T - G)
National savings represent domestic supply of loanable funds per time
period.
Real Interest Rate

Loanable Fund ($)

Q: Why is the national saving curve upward sloping?

If

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Econ 105 Principles of Macroeconomics
Chapter 25 Spring 2022

In the long-run version of our macro model, with actual GDP equal to Y*,
the equilibrium real interest rate and investment rate are determined at
which ID equals NS per period.

The Long Run Connection between Saving and Investment

Q: How does the higher rate of investment today affect the

long run economic growth?

A higher rate of investment increases capital stock.

Q: What would happen to the real interest rate, level of

investment, and the rate of LR economic growth if an
expansionary fiscal policy is implemented today?
Real Interest Rate

NS0

r*

I* Loanable Fund ($)

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Econ 105 Principles of Macroeconomics
Chapter 25 Spring 2022

The expansionary fiscal policy in the short run leads to a reduction in private
investment due to increasing real interest rate, called
“_____________________.” This effect would result in the lower LR
economic growth rate.

Y*

time

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