Econ 115

Lecture 4

Presented by Joshua F. Boitnott, PhD

Economic Growth
• When viewing the economy, people often get
distracted by business cycles as these have a large
impact on our lives.
- For example, increase in the inflation rate or
unemployment rate.
• However, we care about what is happening on
average in the economy, i.e. the trend the
economy is following.
- In other words, we should care about Long-run
Economic Growth or the sustained upward trend in
the economy’s output over time.
Economic Growth
• As with almost all concepts in
economics, there are trade-offs due to
scarcity.
• Delhi and Beijing have terrible air
quality—which is a bad thing.
- Image on right shows the smog.
• But it’s a by-product of a very good
thing: previously unimaginable levels
of economic growth.
Economic Growth
• Since 1980 India and China had a
much higher growth rate than Canada
and the United States.
• Even with the remarkable growth
rates, the standard of living achieved
in Canada in 1900 was attained by
China in 2000 and by India in 2012.
• This is because economist focus on the
real GDP per capita—real GDP divided
by population.
Economic Growth
• How do we calculate the growth rates?
• What explains the diversity in living standards and growth rates
around the world?
• How can the rich countries ensure that they maintain their high
standard of living?
• What policies should the poor countries pursue to promote more
rapid growth in order to join the developed world?

5
Economic Growth – Calculating Growth
• Suppose you are given the following information:

• Let 2017 be the base year.

- Nominal GDP2017 = 10 × $5 + 3 × $10 + 1 × $20 = $100
- Real GDP2017 = 10 × $5 + 3 × $10 + 1 × $20 = $100
- Nominal GDP2018 = 8 × $5 + 2 × $12 + 6 × $25 = $214
- Real GDP2018 = 8 × $5 + 2 × $10 + 6 × $20 = $180
6
Economic Growth – Calculating Growth
• In general, we are interested in what is happening to the Real GDP
RGDP1 −RGDP0
• The Growth Rate of Real GDP is 𝑔 = × 100
RGDP0
- Note: this is just the percentage change (%∆) in Real GDP, previously used this
to calculate the inflation rate
• From the previous page:
- Real GDP2017 = 𝑌2017 = $100
- Real GDP2018 = 𝑌2018 = $180
180−100
- This means the growth rate in Real GDP is 𝑔 = × 100 = 80%
100
214−100
- Growth rate in nominal GDP is 𝑔 = × 100 = 114%
100

7
Economic Growth – Calculating Growth
• Single Year Growth Rate Calculation:
𝑌𝑡+1 − 𝑌𝑡
𝑔=
𝑌𝑡
• Alternatively: 𝑌𝑡+1 = (1 + 𝑔)𝑌𝑡
• Example: If 𝑌𝑡 = 100 and 𝑔 = 2%, then
𝑌𝑡+1 = 1 + .02 100 = 102
• But what happens if the country continues to grow at rate 𝑔 in next
year?
𝑌𝑡+2 = 1 + 𝑔 𝑌𝑡+1

8
Economic Growth – Calculating Growth
• Given 𝑌𝑡+1 = 102 and 𝑔 = 2%, then
𝑌𝑡+2 = 1 + 0.02 102 = 104.04
• What about if the country grows at that rate for another year?
𝑌𝑡+3 = 1 + 𝑔 𝑌𝑡+2
𝑌𝑡+3 = 1 + 0.02 104.04 ≈ 106.12
Or
𝑌𝑡+3 = 1.02 3 × 100 ≈ 106.12
• We can start to see a pattern, what if I just wanted to know what
happens in 𝑛 years if the country grows at rate 𝑔?
𝑌𝑡+𝑛 = 𝑌𝑡 1 + 𝑔 𝑛
9
Economic Growth – Calculating Growth
• We can make the same calculations for real GDP per capita by using
𝑌𝑡
real GDP 𝑌𝑡 and Population 𝑁𝑡 to get: = 𝑦𝑡
𝑁𝑡
𝑦𝑡+1 −𝑦𝑡
• Our growth rate of real GDP per capita is: 𝑔 =
𝑦𝑡
- Notice this is the same percentage change formula as used previously!
- The reason for the general focus: care about average welfare/well being in
the economy.
- If real GDP is growing with population growing faster, then people on average
will have access to less stuff in the economy.
Economic Growth – Example Question
• Suppose the real GDP for Macronesia is $200 million in 2010.
Furthermore, suppose the population in Macronesia is 100,000 in
2010. If the population increases to 105,000 in 2011 while GDP
increases by 5%, then it must be true that real GDP per capita in
Macronesia in 2011:
a) increased.
b) decreased.
c) stayed constant.
d) may have increased, decreased, or remained constant.
Economic Growth
• The Canadian economy produces almost nine times as much per
person as in 1900.
Table 9-1: Canadian Real GDP per Capita

Year Percentage of 1900 Percentage of 2016

Real GDP per Capita Real GDP per Capita
1900 100% 11%
1920 133 15
1940 184 21
1980 556 63
2000 774 87
2016 888 100
 GDP per capita

A quarter of the
world’s
Canada has grown population lives
quickly, while in countries
some nations where the
have stalled. standard of living
is lower than it
was in Canada in
1900.
Economic Growth
Rule of 70
• How did Canada manage to produce over nine times as much real
GDP per person in 2016 than in 1900?
- It’s a gradual process when real GDP per capita grows a few percent per year.
- It’s helpful to use the Rule of 70 that tells us how long it takes for a variable to
double:
70
Doubling time for 𝑋 =
Annual growth rate of 𝑋
- Example: If real GDP per capita is growing at an annual growth rate of 3.5%, it
will double in 70/3.5 = 20 years.
• Notice: even with a relatively small growth rate, these improvements in growth add up
fast due to the power of compounding.
Economic Growth – Example Question
• Let's figure out how long it will take for the average Indian to be as wealthy
as the average western European is today.
- Note: all numbers are adjusted for inflation.
• India's GDP per capita is $3,000, and let’s assume real output per person
grows at 5% per year. Using the Rule of 70, how many years will it take for
India to reach Italy's current level of GDP per capita, about $24,000 per
year?
a) 42 years
b) 14 years
c) 28 years
d) 12 years
Economic Growth
• Figure 9-3 from Personally doubt
the Venezuela
our book and numbers as
rule of 70: stopped
reporting most
- Canada: data
70 internationally in
≈ 46.7
1.5 2016
- India:
70
≈ 16.3
4.3
- China:
70
≈ 8.3
8.4
Economic Growth
• Long-run economic growth depends on one ingredient: rising
productivity.
- Sustained economic growth occurs only when the amount of output
produced by the average worker increases steadily.
- Labour Productivity (often called productivity) is the output per worker for a
given period of time.
• Generally measured per hour.
- Productivity is calculated simply by using real GDP divided by the number of
people working.
• Do not confuse this with per capita, number of people working is not the same as
population!
Economic Growth
• Why does the average worker today produce far more than a century
ago?
• Modern workers have more physical capital, are better educated, and
take advantage of a century’s worth of technological progress.
- Thus, the three main sources of productivity growth are:
• Increase in physical capital (note: often call this capital)
- Physical Capital is human-made resources, such as buildings and machines
• Increase in human capital
- Human Capital is the improvement in labour created by the education and knowledge
embodied in the workforce
• Technological Progress is an advance in technical means of production of goods and
services (Technological Knowledge).
Economic Growth
• Human capital and technological knowledge differ in important ways,
despite being closely related:
- Technological knowledge refers to the society's understanding of how the
world works.
• E.g. an economy with a mature financial system
- Human capital refers to how well the labor force understands the
technological knowledge.
• E.g. financial literacy of the average worker in the economy
• A metaphor: technological knowledge is like the quality of a society’s
textbooks, and human capital is the amount of time the population
has spent on reading them.
19
Economic Growth
• Aggregate production function: 𝑌 = 𝐴 × 𝐹(𝐾, 𝐿, 𝐻) where
- 𝑌: real output (real GDP)
- 𝐾: physical capital
- 𝐿: labour
- 𝐻: human capital
- 𝐹(… ): aggregate production function
- 𝐴: total factor productivity (an estimate of the level of technology)
Economic Growth
• Aggregate production
function exhibits
diminishing returns
to physical capital!

• Consider the graph of

productivity.
Economic Growth
• When the amount of human capital per worker and the state of technology
are held fixed, each successive increase in the amount of physical capital
per worker leads to a smaller increase in productivity
- For example, a second computer improves one’s productivity, but not by as much as
the first computer did.
- Diminishing returns is an “other things equal” phenomenon: it holds true when the
amount of human capital per worker and the technology are held fixed.
• Diminishing returns may disappear if we increase the amount of human
capital per worker, or improve the technology, or both.
- In practice, all the factors contributing to higher productivity rise over time: both
physical capital and human capital per worker increase, and technology advances as
well.
Economic Growth
• Growth Accounting: estimates of the
contribution of each major factor in
the aggregate production function to
economic growth
• Total Factor Productivity: the amount
of output that can be produced with a
given amount of factor inputs
- When total factor productivity increases,
the economy can produce more output
with the same quantity of physical
capital, human capital, and labour.
Economic Growth
• Increases in total factor productivity are central to economic growth.
-Technological progress increases total factor productivity.
• According to Statistics Canada, from 1961 to 2018 Canadian labour
productivity rose 1.9% per year.
- Using growth accounting we can ask what has lead to the increase in
productivity
- 74% of that rise is explained by increases in physical and human capital per
worker
- The rest (26%) is explained by rising total factor productivity—by
technological progress.
Economic Growth
• Elements in Society Correlated with higher growth rates:
1. Savings and investment spending
2. Education
3. Research and development
4. Property Rights/Stability
Economic Growth
• Saving and investment spending:
- In 2019, investment spending was 43% of China’s GDP, compared with only
22% in Canada.
- Money for investment spending comes from savings. Countries that have high
investment spending do so because they have high domestic savings.
- Investment allows countries to purchase more Physical Capital
• The East Asian Miracle provides nice example:
- It took South Korea only 35 years to achieve growth that required centuries
elsewhere.
- Since 1975, the East Asian region has increased real GDP per capita by 6% per
year, more than three times North America’s historical rate of growth.
Economic Growth
• How have the Asian countries achieved such high growth rates?
- Very high savings rates allow businesses to borrow and add more physical
capital per worker.
- Very good basic education has permitted a rapid improvement in human
capital (we’ll discuss more on this soon).
- Substantial technological progress.
Economic Growth
• Economic growth can be especially fast in countries that are playing
catch-up to countries with higher GDP per capita.
- East Asian economies grew quickly partially because they adopted
technologies that already existed.
- The Convergence Hypothesis states differences in real GDP per capita among
countries tend to narrow over time.
• Sometimes called the Catch-up Effect: countries that start off poor tend to grow more
rapidly than countries that start off rich.
• Best Example is South Korea – Canada's GDP growth rate was 2.5%, whereas Korea's was
nearly 7% from 1960 to 1990
- But having a low real GDP per capita is no guarantee of rapid growth, as the
examples of Latin America and Africa demonstrate.
Economic Growth
• Education is important as China’s success
at adding human capital is one key to its
spectacular long-run growth.
- Literacy in China has been increasing more
quickly than in Argentina not because China
is richer but because China has made
education a priority.
• In Canada, more than 90% of primary
and secondary education funding comes
from governments—federal, provincial,
and municipal governments.
Economic Growth
• Research and Development (R&D): spending to create and implement
new technologies
- Scientific advances make new technologies possible. R&D translates scientific
knowledge into useful products and processes.
- U.S. businesses were among the first to adopt R&D: in 1875, Thomas Edison
created the first modern industrial research laboratory.
- Now governments often perform R&D directly, as well as giving businesses
cash refunds and tax credits for their R&D spending.
Economic Growth
• A country without clear property rights and political stability is
unlikely to experience growth.
- Property Rights are the legal rights held by owners of valuable items to
dispose of those items as they choose.
- Intellectual Property Rights are the rights of innovators to accrue the rewards
of their innovations.
- Generally, governments protect intellectual property rights by giving Patents
(government-created temporary monopolies given to innovators for the use
or sale of their innovations).
- Note: property rights holders do not have to be individuals, though generally
easier if it is single person making a decision.
Economic Growth
• Political stability and good governance are also important!
• There’s not much point in investing in a business if rioting mobs are likely to
destroy it.
• The economic success of Canada has been possible because there are good
laws, institutions that enforce those laws, and a stable political system that
maintains those institutions.
• Part of this good governance is creating a trust-worthy banking and financial
system.
- If people distrust banks, they’ll keep gold or cash in safe deposit boxes or under the
mattress, where it cannot be turned into productive investment spending.
Economic Growth
• Is world growth sustainable?
- Sustainable Long-run Economic Growth is long-run growth that can continue
in the face of the limited supply of natural resources and the impact of
growth on the environment
- Note: prior to the 1800s world was on a sustainable path because it was stuck
in a Malthusian Trap.
- Before discussing economic growth and the environment, we should review
Malthus’ theory!
Economic Growth
Malthusian Perspective
• Thomas Robert Malthus (1766-1834) argued that an ever-increasing
population would continually strain a society's ability to feed itself
• His theory is based on 3 assumptions:
1. The economy was agricultural, with two inputs—land and labour.
2. Supply of land was fixed.
• Thus food could only grow arithmetically (i.e. a constant rate) as new land farmed.
3. Human sexual desire worked to increase population.
• Thus Labour (or more accurately population) will grow geometrically (i.e. an exponential
rate) as new humans born.
• He claimed “Moral Restraint” was only path forward for England, i.e. what makes us
different from Rabbits (and why the British did not allow food aid during the Irish Potato
Famine).
- Because population grows faster than food output, people will eventually run
out of food to eat.
34
Economic Growth
Malthusian Perspective
• Luckily, Malthus was wrong... From Galor & Weil, 2005

- Progress in farming technologies

(pesticides, fertilizers, mechanized
farming equipment, new crop
varieties).
- Growth in food production has
been greater than population
growth (graph shows general
growth in output, not just food).
- Unfortunately, some places that
have not experienced growth do
appear to be stuck in world
Malthus described.
35
Economic Growth
• Economic growth and the environmental issues has lead to “Neo-
Malthusian” theories claiming economic growth will be severely
limited by lack of resources.
- Economists believe that modern economies handle scarcity fairly well.
- Resource scarcity leads to high prices, and these high prices provide strong
incentives to conserve the resource and find alternatives.
• For example, after the sharp oil price increases of the 1970s, North American consumers
turned to smaller, more fuel-efficient cars.
- Economic growth tends to have an adverse impact on the environment:
pollution, loss of wildlife habitats, extinction of species, and reduced
biodiversity.
• There’s local environmental degradation and global environmental degradation.
 Economic Growth – Long Run Importance
• One final caveat or caution.
While our focus has been
on economic growth in
terms of GDP per capita, it
may not always capture
individual well-being.
- Norway’s GDP fell due to fall
in oil prices…
- but household income
increased.

37