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Hubbard Solutions Manual

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CHAPTER 7 | Long-Run Economic
Growth: Sources and Policies
Brief Chapter Summary and Learning Objectives
7.1 Economic Growth over Time and around the World (pages 176–181)
Define economic growth, calculate economic growth rates, and describe global trends in
economic growth.
 Real GDP per capita is the best measure of a country’s standard of living. Economic
growth occurs when real GDP per capita increases.
7.2 What Determines How Fast Economies Grow? (pages 181–189)

Use the economic growth model to explain why growth rates differ across countries.
 Labour productivity increases if there is an increase in the amount of capital available to

each worker or if there is an improvement in technology.
7.3 Economic Growth in Canada (pages 189–190)

Discuss fluctuations in productivity growth in Canada.
 Productivity in Canada grew rapidly from the end of World War II until the mid-1970s,
then slowed down for twenty years, then slowed again after 1995.
7.4 Why Isn’t the Whole World Rich? (pages 191–200)

Explain economic catch-up and discuss why many poor countries have not experienced
rapid economic growth.
 Explain economic catch-up and discuss why many poor countries have not experienced
rapid economic growth.
7.5 Growth Policies (pages 200–203)

Discuss government policies that foster economic growth.
 Governments can attempt to increase economic growth through policies that enhance
property rights and the rule of law, improve health and education, subsidize research and
development, and provide incentives for savings and investment.
Key Terms
Catch-up, p. 191. The prediction that the level Economic growth model, p. 181. A model that
of GDP per capita (or income per capita) in poor explains growth rates in real GDP per capita
countries will grow faster than in rich countries. over the long run.
Copyright © 2015 Pearson Canada Inc.

CHAPTER 7 | Long-Run Economic Growth: Sources and Policies 99
Foreign direct investment (FDI), p. 199. The technological change is influenced by economic
purchase or building by a corporation of a incentives and so is determined by the working
facility in a foreign country. of the market system.
Foreign portfolio investment, p. 199. The Patent, p. 187. The exclusive right to produce a
purchase by an individual or a firm of stocks or product for a period of 20 years from the date
bonds issued in another country. the patent is applied for.
Globalization, p. 199. The process of countries Per-worker production function, p. 182. The
becoming more open to foreign trade and relationship between real GDP per hour worked
investment. and capital per hour worked, holding the level of
technology constant.
Human capital, p. 182. The accumulated
knowledge and skills that workers acquire from Property rights, p. 196. The rights individuals
education and training or from their life or firms have to the exclusive use of their
experiences. property, including the right to buy or sell it.
Industrial Revolution, p. 177. The application Rule of law, p. 196. The ability of a government
of mechanical power to the production of goods, to enforce the laws of the country, particularly
beginning in England around 1750. with respect to protecting private property and
enforcing contracts.
Labour productivity, p. 181. The quantity of
goods and services that can be produced by one Technological change, p. 181. A change in the
worker or by one hour of work. quantity of output a firm can produce using a
given quantity of inputs.
New growth theory, p. 186. A model of long-
run economic growth that emphasizes that
Chapter Outline
Google’s Dilemma in China
When Google expanded into China in 2006, the government insisted that Google block searches of
sensitive topics and that it stop showing results from some foreign websites. In late 2009, hackers broke
into Google’s computer system and stole the company’s most important intellectual property. In 2010,
Google decided it would no longer cooperate with the Chinese government to censure Internet searches
and moved its Chinese search service to Hong Kong. China moved away from a centrally planned
economy in 1978, and its real GDP per capita has grown rapidly since. But China is not a democracy, and
the Chinese government has failed to fully establish the rule of law, particularly with respect to the
consistent enforcement of property rights. Without the rule of law, entrepreneurs cannot fulfill their role
in the market system of bringing together the factors of production to produce goods and services.

100 CHAPTER 7 | Long-Run Economic Growth: Sources and Policies
Economic Growth over Time and around the World (pages 176-181)
7.1 Learning Objective: Define economic growth, calculate economic growth rates, and
describe global trends in economic growth.
A. Economic Growth from 1 000 000 BCE to the Present

No sustained economic growth occurred between 1 000 000 BCE and 1300 CE. Significant growth did
not begin until the Industrial Revolution. The Industrial Revolution refers to the application of
mechanical power to the production of goods, beginning in England around 1750. Before that time,
production of goods had relied almost exclusively on human or animal power. First England, and then
other countries such as Canada, the United States, France, and Germany, experienced long-run economic
growth with sustained increases in real GDP per capita.
B. Small Differences in Growth Rates Are Important

Because of compounding, in the long run small differences in economic growth rates result in big
differences in living standards.
C. Why Do Growth Rates Matter?

Growth rates matter because an economy that grows too slowly fails to raise living standards. In some
countries in Africa and Asia, very little economic growth has occurred in the past 50 years, resulting in
severe poverty.
D. “The Rich Get Richer and …”

The world can be divided into two groups: the high-income countries (or the industrial countries) and the
poorer countries (or developing countries). The high-income countries include the countries of Western
Europe, Australia, Canada, Japan, New Zealand, and the United States. The developing countries include
most of the countries of Africa, Asia, and Latin America. In the 1980s and 1990s, a small group of
countries, mostly East Asian countries such as Singapore, South Korea, and Taiwan, experienced high
growth rates and are referred to as the newly industrializing countries.
Extra Solved Problem 7.1

Economic Growth in the Canada since 1981
Figure 7.1 in the textbook shows that the world’s average annual growth rate of real GDP per capita in the
period 1800 to 1900 was 1.3 percent and equalled 2.3 percent from 1900 to 2000. Statistics Canada has
estimated that the real gross domestic product (in 2007 prices) of Canada in 1981 was $789.8 billion. The
table below shows what real GDP would be for 1982 assuming that the growth rate of real GDP was 1.3
percent, 2.3 percent, and 3.3 percent from 1981 to 1982. The estimated values for 1982 were obtained by
multiplying $789.8 billion by 1.013, 1.023 and 1.033, respectively.
Estimated Real GDP for Canada
for Various Growth Rates
1.3% 2.3% 3.3%
1982 $800.1 billion $808.0 billion $815.9 billion
The differences in estimated real GDP for 1982 seem small, but how different would GDP be if these
growth rates continued through 2012?

Estimate real GDP for Canada if, from 1982 to 2012, the economy grew at three different growth rates:
(a) 1.3 percent annually, (b) 2.3 percent annually, and (c) 3.3 percent annually.
Source: Statistics Canada Table 380-0064.
Solving the Problem

Step 1: Review the chapter material.
This problem is about the importance of economic growth over time, so you may want to
review the section “Economic Growth over Time and around the World,” which begins on
page 176 in the textbook.
Step 2: Answer the problem by estimating real GDP for Canada if, from 1982 to 2012, the
economy grew at three different growth rates: (a) 1.3 percent, (b) 2.3 percent, and (c)
3.3 percent.
The table below shows what real GDP would be in 2012 if real GDP grew at the three
different rates.
Estimated Real GDP for Canada

for Various Growth Rates
1.3% 2.3% 3.3%
2012 $1,178.7 billion $1,598.3 billion $2,160.9 billion
The actual real GDP for 2012 was $1,302 billion, which corresponds to approximately 1.6
percent growth rate. This is about 60% of the estimated real GDP when assuming a 3.3
percent rate of growth, and is 81% of the estimated real GDP assuming a 2.3 percent rate of
growth. These calculations show how apparently small differences in growth rates,
compounded for just 31 years, can result in very different levels of real GDP.
What Determines How Fast Economies Grow? (pages 181-189)

7.2 Learning Objective: Use the economic growth model to explain why growth rates differ
across countries.
The economic growth model explains growth rates in real GDP per capita over the long run. This model
focuses on the causes of long-run increases in labour productivity, which is the quantity of goods and
services that can be produced by one worker or by one hour of work. Economists believe that two key
factors determine labour productivity: the quantity of capital per hour worked and the level of technology.
Technological change is a change in the quantity of output a firm can produce using a given quantity of
inputs. There are three main sources of technological change:
1. Better machinery and equipment, such as the steam engine and computers.
2. Increases in human capital, which is the accumulated knowledge and skills that workers acquire
from education and training or from their life experiences.
3. Better means of organizing and managing production, such as the just-in-time system firms use to
assemble goods from parts that arrive at the factory at the exact time needed.

A country’s standard of living will be higher the more capital workers have available on their jobs, the
better the capital, the more human capital workers have, and the better job business managers do in
organizing production.
A. The Per-Worker Production Function

The economic growth model can be illustrated by using the per-worker production function, the
relationship between real GDP per hour worked and capital per hour worked, holding the level of
technology constant. Increases in the quantity of capital per hour worked result in movements up the per-
worker production function. Equal increases in the amount of capital per hour worked lead to diminishing
increases in output per hour worked: The addition of one more unit of one input to a fixed quantity of
another input makes output increase by smaller additional amounts.
B. Which Is More Important for Economic Growth: More Capital or Technological

Change?
Technological change helps economies avoid diminishing returns to capital.
C. Technological Change: The Key to Sustaining Economic Growth

Technological change shifts up the per-worker production function and allows an economy to produce
more real output per hour worked with the same quantity of capital per hour worked. In the long run, a
country will experience an increasing standard of living only if it experiences continuing technological
change.
D. New Growth Theory

The new growth theory is a model of long-run economic growth that emphasizes that technological
change is influenced by economic incentives and so is determined by the working of the market system.
Paul Romer, who developed the new growth theory, argues that the rate of technological change is
influenced by how individuals and firms respond to economic incentives. Firms add to an economy’s
stock of knowledge capital when they engage in research and development or otherwise contribute to
technological change. Romer argues that the accumulation of knowledge capital is subject to diminishing
returns at the firm level, but at the level of the entire economy, knowledge capital is subject to increasing
returns. The use of knowledge capital is nonrival because one firm’s use of that knowledge does not
prevent another firm from using it. Romer points out that firms are unlikely to engage in research and
development up to the point where the marginal cost of the research equals the marginal return from the
knowledge gained because other firms will gain much of the marginal return. Government policy can help
increase the accumulation of knowledge capital in three ways:
1. Protecting intellectual property with patents and copyrights. A patent is the exclusive right to
produce a new product for a period of twenty years from the date the patent is applied for.
2. Subsidizing research and development.
3. Subsidizing education.
These policies can bring the accumulation of knowledge capital closer to the optimal level.
E. Joseph Schumpeter and Creative Destruction

The new growth theory has revived interest in the ideas of Joseph Schumpeter. Schumpeter developed a
model of growth that emphasized his view that new products drive older products—and the firms that
produce them—out of the market. For Schumpeter, the key to rising living standards is not small changes
in existing products but new products that meet consumer needs in qualitatively different ways. The

entrepreneur is central to economic growth. Successful entrepreneurs can use their profits to finance the
development of new products.
F. Thomas Malthus and Endogenous Population Growth

In 1798, Thomas Malthus considered the possibility that was endogenous, not exogenous. He believed
that a higher standard of living leads to better nutrition, sanitation, and medical care, and thus to
population growth. He also believed that an increase in the standard of living encourages greater fertility
and inevitably leads to further population growth. Recent evidence on cross-country data shows negative
correlation between higher real GDP growth and population growth.
Economic Growth in Canada (pages 189-190)

7.3 Learning Objective: Discuss fluctuations in productivity growth in Canada.
The economic growth model can help us understand the record of growth in Canada.
A. Economic Growth in Canada since 1950

Productivity in Canada grew rapidly from the end of World War II until the mid-1970s. Growth then
slowed down for 20 years. Beginning in the mid-1990s, the growth rate declined again, though it
remained at roughly the same rate as for the 1973–1994 period.
B. What Caused the Productivity Slowdown of 1973–1994?

Leading explanations for the productivity slowdown of the mid-1970s to the mid-1990s have to do with
measurement problems from
a. changing technology
b. increases in the production of services
c. improvements in the environment and in health and safety.
Because all high-income economies began producing more services and fewer goods and enacted
environmental regulation at the same time, explanations of the productivity slowdown that emphasize
measurement problems become more plausible. However, economists have not reached a consensus on
why the productivity slowdown took place.
C. Can Canada Maintain High Rates of Productivity Growth?

Some economists argue that the development of a “new economy” based on information technology can
lead to higher productivity growth in the future. Faster data processing has had a major effect on nearly
every firm. Many economists are optimistic that the increases in productivity will continue. Further
innovations in information and communications technology may continue to contribute to strong
productivity growth. Wireless communications have the potential to significantly increase labour
productivity.

Canadian Productivity Growth and Employment
The textbook describes the productivity slowdown from 1973 to 1994 in which the annual growth rate of
real GDP per hour worked in Canada was 1.1 percentage point per year lower than during the 1950–1972
period. Although the reasons for this anemic growth are still not certain, the economic growth continued
to slow to an annual average rate of 1.6 percent from 1995 to 2011. Others have pointed to a dark lining
in this silver cloud. The economic expansion that began after the 2001 recession was frequently referred
to as a “jobless recovery” in newspaper and magazine articles. Some observers argued that faster

productivity growth allowed employers to increase production without increasing employment. Although
employment growth subsequently increased, the concern expressed for workers’ jobs highlights two
different views of productivity. In the U.S. Federal Reserve Bank of San Francisco’s Economic Letter,
Carl Walsh wrote,
If higher productivity allows firms to shed workers, how can it raise wages and living
standards? If productivity does lead to improved wages and living standards, why do so many
feel the recent productivity growth has left workers behind?
Walsh notes that productivity growth and changes in technology cause structural changes that result in
increased production and employment in some industries and reductions in production and employment in
other industries. For example, the growth in demand for word processors and personal computers resulted
in a decline in the demand for typewriters and some types of office workers. Small changes in overall
employment mask what often are large increases in employment and unemployment in individual
industries. In other words, the negative effect of productivity on employment occurs in the short run,
while the positive effect of productivity on employment occurs in the long run.
Source: Carl E. Walsh, “The Productivity and Jobs Connection: The Long and the Short of It.” FRBSF Economic Letter. July 16,
2004.
The average annual growth rate of real GDP per hour worked from 1950 to 1972 was 2.8 percent.
Examine the fluctuations in the annual unemployment rate for this period in Figure 7.5 in the textbook. Is
the behaviour of the unemployment rate consistent with Carl Walsh’s explanation of the effect of
productivity growth on employment when we look at Canadian data?
Solving the Problem

This problem is about fluctuations in productivity growth, so you may want to review the
section “Economic Growth in Canada,” which begins on page 189 in the textbook.
Step 2: Answer the problem by explaining whether the behaviour of the unemployment rate
consistent with Carl Walsh’s explanation of the effect of productivity growth on
employment.
Yes, Walsh’s explanation is consistent with the behaviour of unemployment. Despite the
relatively large increases in productivity from 1950 to 1972, the rate of unemployment did
not have an upward trend. Most of the fluctuation in the unemployment rate occurred as a
result of business cycle fluctuations. This observation is consistent with the argument that
increases in productivity lead to increased employment in the long run by raising the real
wage workers receive. Other data are needed to show how much total employment changed
and which industries experienced job gains and job losses.
Extra Making
Productivity Gains Help Make U.S. Manufacturers
the
More Competitive
Connection
It’s a story all too familiar to many Americans: Caterpillar, the world’s largest manufacturer of
construction and industrial mining equipment, tried to persuade workers at one of the company’s U.S.
locomotive-assembly plants to accept lower wages in order to reduce its wage and benefit costs, which
were much higher than they were at a Caterpillar plant in another country. What was different about the
story was the location of the two plants: Wage and benefit costs at Caterpillar’s rail-equipment plant in
LaGrange, Illinois, were less than half of those at the company’s locomotive-assembly plant in Ontario.

Navistar International Corp., formerly the International Harvester Company, manufactures diesel engines,
buses, and other business equipment. Navistar also sought to lower costs at its plant in Ontario. After
failing to reach an acceptable agreement for more-flexible work rules and lower wage costs with the
Canadian Auto Workers, the company decided to relocate the plant to Springfield, Ohio. Navistar’s Chief
Executive Dan Ustian commented, “I am a firm believer that North America and the U.S. can be very
competitive in manufacturing, especially when it is a technical kind of job.” Bridgestone Corp. of Japan
spent over $1 billion to expand a plant in South Carolina that makes radial tires. Gary Garfield, CEO of
Bridgestone’s Americas unit, explained that the higher productivity of U.S. workers trumped lower labour
costs in other potential plant locations in Mexico or other Latin American countries.
What has made U.S. manufacturers more efficient and more competitive in recent years? The recession of
2007–2009 slowed the growth of wages, and many firms have incorporated flexible work practices and
increased automation in order to increase productivity. As a result, U.S. productivity in 2010 grew by
more than 4 percent and averaged over 2.5 percent over the previous ten years. Labour costs actually
decreased by 13 percent among U.S. manufacturers from 2000 to 2010. Over this same period, unit labour
costs rose in Germany (by 2.3 percent), in Canada (by 18 percent), and in South Korea (by 15 percent).
Other factors that contributed to holding down U.S. manufacturing costs include lower energy prices, due
mostly to increased production of natural gas from shale, and a lower exchange rate for the dollar.
A report by the Conference Board of Canada suggests that Canada’s lower productivity, relative to the
United States is a result of lower levels of innovation in this country as well as lower levels of investment
in both human and physical capital particularly with respect to STEM subjects and information and
communications technology.
Sources: James R. Haberty and Kate Linebaugh, “In U.S., a Cheaper Labor Pool,” Wall Street Journal, January 6, 2012; Erik
Brynjolfsson, “Not All the Economic News is Bad,” digitopoly.org, October 27, 2011, and “Labour Productivity Growth” The
Conference Board of Canada 2013.
Why Isn’t the Whole World Rich? (pages 191-200)

7.4 Learning Objective: Explain economic catch-up and discuss why many poor countries have
not experienced rapid economic growth.
The economic growth model tells us that economies grow when the quantity of capital per hour worked
increases and when technological change takes place. The profitability of using additional capital or better
technology is generally greater in a developing country than in a high-income country. The economic
growth model predicts that poor countries will grow faster than rich countries. Catch-up is the prediction
that the level of GDP per capita (or income per capita) in poor countries will grow faster than in rich
countries. The paradox is that lower-income industrial countries have been catching up to the higher-
income industrial countries, but the developing countries as a group have not been catching up to the
high-income countries as a group.
A. Catch-up: Sometimes but Not Always

You can use a graph to illustrate whether catch-up is happening. The initial level of GDP per capita is
measured along the horizontal axis and the vertical axis shows the rate at which GDP per capita is
growing. Low-income countries should be in the upper-left part of the graph and high-income countries
should be in the lower-right part of the graph. Some countries that had low levels of real GDP per capita
in 1960, such as Niger and Madagascar, had lower levels of real GDP per capita in 2009 than in 1960.
Other countries that started with low levels of real GDP per capita, such as Malaysia and South Korea,
grew rapidly. In the textbook, see Figure 7.7 and Figure 7.8.

B. Why Haven’t Most Western European Countries, Canada, and Japan Caught Up
to the United States?
Over the past 20 years, other high-income countries have fallen further behind the United States. Real
GDP per capita in Canada, Japan, and the five largest countries in Western Europe increased relative to
the United States between 1960 to 1990, but none of these countries has experienced catch-up since 1990.
Many economists believe there are two explanations for the failure of these countries to catch-up with the
United States: The greater flexibility of U.S. labour markets and the greater efficiency of the U.S.
financial system.
C. Why Don’t More Low-Income Countries Experience Rapid Growth?

Some poor countries do not experience rapid growth for four main reasons:
1. Failure to enforce the rule of law, which is the ability of a government to enforce the laws of the
country, particularly with respect to protecting private property and enforcing contracts
2. Wars and revolutions
3. Poor public education and health
4. Low rates of saving and investment
Property rights are the rights individuals or firms have to the exclusive use of their property, including
the right to buy or sell it.
D. The Benefits of Globalization

One way for a developing country to break out of the vicious cycle of low saving and investment and low
growth is through foreign direct investment (FDI), which is the purchase or building by a corporation of
a facility in a foreign country.
Foreign portfolio investment is the purchase by an individual or a firm of stock or bonds issued in
another country. Globalization is the process of countries becoming more open to foreign trade and
investment.
7.5 Growth Policies (pages 200–203)

Learning Objective: Discuss government policies that foster economic growth.
A. Enhancing Property Rights and the Rule of Law

A market system cannot work well unless property rights are enforced. Entrepreneurs are unlikely to risk
their own funds, and investors are unlikely to lend their funds to entrepreneurs, unless property is safe
from being arbitrarily seized. In many developing countries, the rule of law and property rights are
undermined by corruption. Research has shown that countries where corruption is most widespread grow
much more slowly than countries where corruption is less of a problem.
B. Improving Health and Education

As people’s health improves and they became stronger, and less susceptible to disease, they also become
more productive. Many economists believe that government subsidies to education have played an
important role in promoting economic growth.

The rising incomes that result from economic growth can help developing countries deal with brain drain.
Brain drain refers to highly educated and successful individuals leaving developing countries for high-
income countries.
C. Policies That Promote Technological Change

Government policies that facilitate access to technology are crucial for low-income countries. The easiest
way for developing countries to gain access to technology is through foreign direct investment. In high-
income countries, government policies can aid the growth of technology by subsidizing research and
development.
D. Policies That Promote Saving and Investment

Governments can increase incentives for firms to engage in investment in physical capital by using
investment tax credits. These credits allow firms to deduct from their taxes some fraction of the funds
they have spent on investment.
E. Is Economic Growth Good or Bad?

The arguments against further economic growth tend to be motivated either by concern about the effects
of growth on the environment or by concern about the effects of the globalization process that has
accompanied economic growth in recent years. Economic analysis can contribute to the debate over the
consequences of economic growth, but it cannot resolve the issue.

What Is the Proper Role for Government in Promoting Growth?
One popular explanation for the persistent poverty of developing nations is a lack of natural resources.
But Hong Kong and Japan have relatively few natural resources, yet both experienced more rapid
economic growth in recent decades than nations with abundant supplies of resources. Economist Paul
Romer has argued that it is ideas, not natural resources, that poor countries lack most: “If a poor nation
invests in education and does not destroy the incentives for its citizens to acquire ideas from the rest of
the world, it can rapidly take advantage of the publicly available part of . . . knowledge.”
In Canada and developed countries most economists support three government policies that encourage the
production and dissemination of new knowledge:
 Subsidies for education

 Competitive grants for basic research
 Patents and copyrights
Romer warns that it is important to limit government’s power over economic policy. He states that most
economists favour government subsidies for education and private research, but if government officials
have power over economic policy, they may use that power to divert the results of research to narrow
special interests.
Source: Paul M. Romer, “Economic Growth,” The Concise Encyclopedia of Economics.
http://wwweconlib.org/library/Enc/EconomicGrowth.html.
a. Why do economists believe that government should subsidize education and basic research?
b. Paul Romer warns that government officials may use their power to divert the results of research
to narrow special interests. Explain Romer’s concern.

Solving the Problem

This problem is about policies that can foster economic growth, so you may want to review
the section “Growth Policies,” which begins on page 200 in the textbook.
Step 2: Answer part (a) by explaining why economists believe that government should
subsidize education and basic research.
Private firms have little incentive to invest resources in activities that, if successful, are not
profitable. The social returns to investment in education and basic research are significant,
but these returns are spread throughout the economy. Therefore, firms may not undertake
research that would increase economic growth and benefit the whole economy because the
research would not be profitable for the firms. A government subsidy may be necessary to
provide firms with the incentive to invest in basic research.
Step 3: Answer part (b) by explaining Paul Romer’s concern that government officials may use
their power to divert the results of research to narrow special interests.
Elected officials are likely to favour projects that are located in their own provinces or
districts rather than projects that have the greatest social returns. For example, politicians
from Quebec are apt to favour subsidies for milk and cheese production because the subsidy
benefits dairy farmers in their province.
Extra Making
The Role of Local Government in Promoting Economic
the
Growth in China
Connection
For over two decades, economic growth in China has been among the highest of any nation, often
exceeding 7 to 9 percent annually. A key to achieving economic growth in a market economy is
protection of rights to private property. However, China has a relatively weak judicial system and a poor
property rights environment. An explanation for China’s success in attracting private investment despite a
poor track record in protecting property rights is offered by X. Zhang, who argues that local Chinese
governments engage in vigorous competition for investment that benefits their own jurisdictions. The
uncertainty of doing business is very high, and as a result, the cost of completing contracts is high as well.
To overcome these obstacles, businesses often partner with local government officials who work hard to
provide a stable environment for these businesses and provide protection from local government
regulations. The result is strong protection for investors within a weak system of protection of property
rights for rural landowners. Farmers and other Chinese citizens are often forced to sell their rights to land
for allegedly “public purposes”—that is, for new private businesses. Although this system has produced
considerable prosperity for China, it has come at the expense of increased social tension, especially
among current and former landowners. It may be difficult to sustain China’s high rate of economic
growth far into the future without addressing this potential source of social conflict.
Source: Karol Boudreaux and Paul Dragos Aligica, “Legislation and creation by fiat,” in Paths to Property (London: The Institute of
Economic Affairs, 2007), pp. 65–66.
Extra Economics in Your Life:

Can Economic Growth in China Have an Impact on You?
Question: China has been enjoying higher economic growth for the past decade than has Canada. How can
China’s rapid economic growth affect your welfare (assuming you live in Canada)?

Answer: The fact that China is experiencing rapid economic growth allows firms located in China to
manufacture more products at a lower cost. So consumers in Canada are able to buy lower-priced imports
from China, while growing prosperity in China will encourage consumers and firms to buy more products
from other countries, including Canada. Of course, some firms and workers in Canada will be made
worse off if these firms close as a result of competition from Chinese firms.
Extra AN INSIDE LOOK News Article to Use in Class

Visit www.myeconlab.com for current An Inside Look news articles.
SOLUTIONS TO END-OF-CHAPTER EXERCISES

Answers to Thinking Critically Questions
1. As the article suggests, the Chinese government can spend more on promoting technological
change, such as replacing existing capital with more productive capital to make manufacturing more
efficient. Technological change causes the per-worker production function to shift up so that real GDP per
hour worked is higher at any given level of capital per hour worked.
2. A “flimsy social safety net” means that China lacks a strong system of unemployment benefits
and payments to the disabled and elderly, like the Social Security system in Canada and the United States.
Because households in China cannot rely on the government for financial support if they lose their jobs,
become disabled, or want to retire, they have a strong incentive to save, rather than spend, a large fraction
of their incomes. So, compared with Canada, the United States, and other high-income countries, we
would expect saving rates to be higher in China.
Review Questions
Economic Growth over Time and around the World
Review Questions
1.1 A country’s economic growth matters because living standards tend to rise with economic
growth. Higher economic growth provides a country with more opportunities to improve the lives of its
citizens by, for example, increasing average life expectancy.
1.2 The total percentage increase is the percentage increase in real GDP from 2002 to 2012. It is not
an annual growth rate. The average annual growth rate is the growth rate at which the value for real GDP
in 2002 would have to grow on average each year to end up with the value for real GDP in 2012.
What Determines How Fast Economies Grow?

across countries.
2.1 Diminishing returns to capital imply that, holding technology constant, additional capital per hour
worked results in smaller and smaller increases in real GDP per hour worked. Therefore, sustained
increases in real GDP per hour worked require more than continuing increases in capital per hour worked.

To maintain high growth rates despite diminishing returns to capital, economies must experience
technological change.
2.2 Firms are likely to underinvest in research and development because other firms will gain much
of the additional return from the research and development. To increase the accumulation of knowledge
capital, governments can protect intellectual property with patents and copyrights, subsidize research and
development, and subsidize education.
2.3 The new growth theory is a model of long-run economic growth that emphasizes that
technological change is affected by economic incentives and so is determined by the working of the
market system. The Solow growth theory does not seek to explain what determines technological change,
but instead assumes that technological change occurs because of chance scientific discoveries. The new
growth theory, besides seeking to explain factors that influence technological change, incorporates
knowledge capital and its increasing returns to the economy.
7.3 Economic Growth in Canada

Learning Objective: Discuss fluctuations in productivity growth in Canada.
3.1 The growth rate of productivity increased from 1870 through the mid-1970s, then slowed
somewhat for the next 40 years. The slowdown in productivity growth most likely resulted from the
measurement problem of the economy producing a larger share of services relative to goods and from
stricter environmental and health standards that may have increased overall well-being but not measured
GDP. In response to higher oil prices, some firms switched to production technologies that were less
energy intensive but which also produced less output per worker hour. The scores on some standardized
exams declined during this time period, which may indicate a declining quality of the labour force.
Lower-quality workers may have more difficulty adapting to new technology, which could reduce the
growth rate of productivity. Beginning in 1995, the rapid spread of information technology may have
spurred productivity increases.
Why Isn’t the Whole World Rich?

4.1 Increases in the quantity of capital per hour worked and the adoption of new technology should
occur at a high rate in poor countries, because the profitability of using additional capital or better
technology is generally greater in a poor country than in a rich country. Some poor countries have been
catching up to rich countries, but many have not.
4.2 In many European countries, government regulations make it difficult for firms to fire workers
and thereby make firms reluctant to hire workers. Many younger workers find a job and tend to remain in
the job even if their skills do not match up with the characteristics of the job, which decreases labour
productivity. Many European countries also have work rules that restrict the tasks firms can ask workers
to perform and the number of hours they can work. These work rules reduce the ability of firms to use
new technologies that require workers to learn new skills, perform new tasks, or work during the night or
early morning. Most Western European countries also have more extensive unemployment compensation,
which tends to increase the unemployment rate and the fraction of the labour force that is unemployed for
more than one year, which tends to decrease the rate of growth of labour productivity.

The level of legal protection of investors in North American financial markets encourages both North
American and foreign investors to buy stocks and bonds issued by firms in North America, allowing firms
to obtain funds needed for investment and implementation of new technologies. Additionally, the ability
of venture capital firms to finance technology-driven start-up firms may give Canada and the United
States an advantage in bringing new products and new processes to market.
4.3 The main reasons many poor countries have experienced slow growth are the failure to enforce
the rule of law, wars and revolutions, poor public education and health, and low rates of saving and
investment.
4.4 Globalization refers to the process of countries becoming more open to foreign trade and
investment. Globalization can help a developing country break out of the vicious cycle of low saving and
investment and low growth by providing access to funds and technology from foreign direct investment
and foreign portfolio investment.
7.5 Growth Policies

5.1 Governments can aid economic growth through policies that enhance property rights and the rule
of law, improve health and education, subsidize research and development, and provide incentives for
saving and investment.
5.2 Economic growth is associated with higher living standards, improved health, improved working
conditions, and longer life expectancy. However, some policymakers and commentators argue that
economic growth has been contributing to income inequality, global warming, deforestation, and other
environmental problems. Whether continued economic growth will always improve economic well-being
is a normative question and cannot be settled by economic analysis.
Problems and Applications
Economic Growth over Time and around the World

1.1 The finding of the importance of market efficiency in long-run economic growth by Shiue and
Keller supports North’s argument that a government can promote economic growth by protecting private
property rights and wealth, as the British government did beginning with the Glorious Revolution of 1688.
1.2 Growth Rates

Average Annual
2008 2009 2010 Growth Rate
Brazil 5.16% −0.65% 7.49% 4.00%
Mexico 1.19 −6.16 5.42 0.15
Thailand 2.56 −2.36 7.78 2.66
a. During 2008, Brazil experienced the highest economic growth rate of 5.16 percent.

b. During 2009, Mexico experienced the worst economic recession with real GDP declining by
6.16 percent.
c. Between 2008 and 2010, Brazil experienced the highest average annual growth rate of 4.00
percent.
d. It does not matter that each country’s real GDP is measured in a different currency. Growth
rates are measured as percentage changes, which are not dependent on the specific currency
being used.
1.3 You will have earned more on your Andover Bank CDs due to the compounding earned in 2012
and 2013 on the extra $30 earned on the Andover Bank CD in 2011.
Bank Value of CD at end of year

2011 2012 2013
Andover Bank $1,050.00 $1,102.50 $1,157.63
Lowell Bank $1,020.00 $1,081.20 $1,156.88
1.4
Real GDP per capita Annual
Year (2000 prices) growth rate
2006 $43,332
2007 43,726 0.91%
2008 43,178 −1.25
2009 41,313 −4.32
2010 42,205 2.16
a. The percentage increase in real GDP per capita between 2006 and 2010 was
 $42,205 − $43,332 
  × 100 = − 2.60%
 $43,332  .
b. The average annual growth rate in GDP per capita between 2006 and 2010 can be measured as
the average of the annual growth rates in the above table, which is −0.63 percent.
1.5 a. Real GDP per capita most likely did not increase significantly from the near elimination of
measles and the large decrease in childhood deaths, but the standard of living measured in
terms of health did increase significantly. One reason why falling infant and childhood
mortality could contribute to lowering GDP per capita is that lower mortality results in a larger
population and therefore a higher denominator in the GDP per capita ratio. The reduction in
disease would also mean that resources could be used for purposes other than treating disease,
which would raise living standards; and for a given level of food intake, net nutrition increases
with lower incidence of disease. These last considerations indicate reductions in disease may
lay the foundation for future increases in real GDP per capita.
b. For a developing country, the elimination of measles and childhood deaths from diarrhea is
more achievable than sustained increases in real GDP per capita. Fewer additional resources
and less time are required to achieve the elimination of disease than the additional investment
and the institutional changes needed for sustained increases in real GDP per capita.

1.6 If ideas and inventions, such as the importance of ABCs and vaccines for DPT (diphtheria,
pertussis, and tetanus), flow more readily than process technologies, such as laws and inventory
management systems, then low-income countries will be able to increase their standard of living as
measured by health and education faster than they will be able to increase real GDP per capita.
What Determines How Fast Economies Grow?

across countries.
2.1 Changes in work rules represent a better means of organizing and managing production, which
economists consider an improvement in technology.
2.2 (a) results in a movement along the per-worker production function.
(b) and (c) result in a shift in the per-worker production function because they are likely to lead to
technological change, or an increase in real GDP per hour worked, holding capital per hour
worked constant.
2.3 a. False, because technology is assumed constant along a given per-worker production function.
b. False, because the movement from point B to point C represents technological change, which
occurs despite the existence of diminishing returns to capital.
c. True, because point C represents both a higher level of capital per worker and a higher level of
technology than point A.
2.4 This strategy ran into the problem of diminishing returns to capital. The policy of very high rates
of investment with little emphasis on technological change meant that the capital stock was increasing
much more rapidly than technology. Continuing rapid increases in capital per hour worked led only to
diminishing increases in output per hour worked. With these diminishing marginal returns, the growth
rate of real GDP per capita stagnated.
2.5 In the traditional economic growth model, technological change is exogenous. This means that
the traditional model does not try to explain technological change. Technological change is endogenous in
the new growth theory, and entrepreneurs play a key role in the development and adoption of new
technology.
2.6 Because even though they are not spending their own money, salaried managers in Canada are
judged by the profitability of the company, which often depends on the adoption of new technologies.
7.3 Economic Growth in Canada

Learning Objective: Discuss fluctuations in productivity growth in Canada.
3.1 The growth rates might be lower if they were calculated for real GDP per capita instead of per
hour worked because the number of hours worked per person in Canada has decreased in the years since
1900.
3.2 Because labour productivity is measured by real GDP per hour worked, an increase in labour
productivity means that workers are able to increase per hour production. If labour productivity increased
while output, or real GDP, decreased, this indicates that the hours devoted to production were decreasing.

More productive workers working fewer hours will increase labour productivity but may also decrease
output.
3.4 Future labour productivity growth rates will decline if Gordon’s observations are correct. The
higher labour productivity growth rates that began in the mid-1990s were due partly to advances in
information and communication technology. To the extent that these advances have moved more to
consumer enjoyment rather than business productivity, then labour productivity growth rates will decline.
Why Isn’t the Whole World Rich?

4.1 The catch-up effect predicts that countries with a lower level of GDP per capita will grow faster
than countries with a higher level of GDP per capita. In the table, China’s GDP per capita in 1960 was the
lowest at $363 and its growth between 1960 and 2009 was the highest at an average annual rate of 6.23
percent, which is consistent with the catch-up prediction. On the other hand, some countries with
relatively low GDP per capita in 1960, such as Uganda and Madagascar, also experienced relatively low
growth rates, which is not consistent with the catch-up prediction.
4.2 a. No, these data do not support the catch-up prediction. The countries with the highest initial
levels of real GDP per capita have growth rates of real GDP per capita similar to the countries
with average initial levels of real GDP per capita.
b. Yes, these data support the catch-up prediction. The countries with the lowest initial levels of
real GDP per capita have the highest growth rates of real GDP per capita, and the countries
with the highest initial levels of real GDP per capita have the lowest growth rates of real GDP
per capita.
c. No, these data do not support the catch-up prediction. The countries have roughly the same
growth rates of real GDP per capita regardless of their initial levels of real GDP per capita.
4.3 Globalization makes it possible for poor countries to attract foreign investment and gain access to
the best technology. Without the free flow of trade and investment that globalization represents, poor
countries would have to rely primarily on their own resources. Refer to Figure 7.10 for the relationship
between the level of globalization and the growth rate of real GDP per capita.
4.4 The observation that “Ecuador and Colombia both have perfectly clean parking slates, despite the
experts’ view of them as fairly corrupt places,” does not invalidate Fisman’s and Miguel’s conclusions
about whether the parking violations data provide evidence in favour of there being a culture of
corruption in some countries. Fisman and Miguel found that as the level of corruption in a country
increases, so does the number of parking violations by the country’s United Nations delegates. They
found that the 15 percent of countries that are most corrupt had more than ten times as many parking
violations as the 15 percent of countries that are least corrupt. Just because their observation does not hold
in 100 percent of cases does not mean that the observation is not valid. Despite a few exceptions, in
general, the statistics support Fisman’s and Miguel’s observation.
4.5 For the most part, the Roman Empire lacked the secure private property rights required for a
market system to work. If modern economic growth had begun 1700 years earlier than it did, the standard
of living today would be many times higher than it is.

7.5 Growth Policies

5.1 Limits on political freedom could eventually become an obstacle to China’s continued rapid
economic growth. The failure of the Chinese government to fully establish the rule of law, particularly
with respect to the consistent enforcement of property rights, makes it more difficult for entrepreneurs to
fulfill their role in the market system in bringing together the factors of production to produce goods and
services. Further, whether increased political freedom comes gradually or through a violent revolution
would affect growth.
5.2 The lower birthrate will lead to a lower proportion of workers in their twenties and thirties, and a
higher proportion of workers in their sixties and older. The older workers as a group will be less educated,
less healthy, and less productive. High rates of spending on investment will lead to high rates of growth in
the short run, but not the long run, because of diminishing returns to capital. The increased spending on
investment moves China along its per-worker production function but does not shift up the function.
Ultimately, China will need to achieve technological advance, which will shift up the per-worker
production function.
5.3 It is likely to be easier for the typical developing country to improve the state of public health
than to improve the average level of education. Improvement in public health involves increased
vaccinations against infectious diseases, improved access to treated water, and improved sanitation.
Improving the average level of education, on the other hand, typically requires building new and better
schools, purchasing textbooks and other educational materials, and hiring large numbers of teachers. The
expense and organizational resources involved have often made it difficult for developing countries to
significantly improve the average level of education.
5.4 a. The passage of an investment tax credit is likely to increase the rate of economic growth in
Canada because the credit will give firm an incentive to purchase more capital, thereby
increasing the capital to labour ratio (K/L).
b. Deductibility of provincial taxes is unrelated to any of the factors that cause economic growth.
c. Providing more funds for low-interest loans to college students is likely to increase the rate of
economic growth in Canada. When more students receive a college education, the level of
human capital increases, which is a form of technological improvement.
5.5 A free press could serve as a watchdog against corruption, which undermines the rule of law and
property rights. Over time, crusading newspapers could help reduce corruption and improve the rule of
law.
5.6 The environment might be considered as a “normal good,” whose demand increases as
consumers’ incomes increase. From this perspective, more people in high-income countries than in low-
income countries tend to be concerned about the environment and thus consider rapid economic growth
less desirable.

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Biographical notes.
In 1781 “Jas. Bailey” is shown as the occupier of the house. For the
next few years no name is given, but in 1785 that of Thomas Burn appears
and continues for the remainder of the century.
In the Council’s collection are:—
[738]No. 23, Bedford Square. Doors and doorcase in front room on
ground floor (photograph).
No. 24, Bedford Square. Entrance doorway (photograph).
LXXIX.—No. 25, BEDFORD SQUARE.
Ground landlord and lessee.
Ground landlord, His Grace the Duke of Bedford, K.G.; lessee,
the Rev. Lewis Gilbertson, M.A., F.S.A.
General description and date of
structure.
On 20th November, 1777, a lease[739] was granted of a plot of
ground with three messuages thereon, on the north side of Bedford
Square, being the eleventh, twelfth and thirteenth houses eastward
from Tottenham Court Road, abutting east upon ground to be built
upon, west upon a messuage in Bedford Street (now Bayley Street),
and north upon ground belonging to the City of London. The
dimensions of the plot are said to be: 99¼ feet on the south, 73 feet
on the east, 67½ feet on the west, and 98½ feet on the north, thus
corresponding to the sites of Nos. 24 to 27 (four houses) at the
present day.
No. 25 is the westernmost house of the northern block
included in the design for the square, the two houses adjoining to the
west being in harmony with the remaining premises in Bayley Street.
The house is of special interest.
The vestibule is divided from the hall by a screen similar in
architectural character to the front doorcase, and still retains the
original fanlight. The staircase is of stone with a wrought-iron
balustrade and mahogany handrail. Beneath the first floor landing is
a moulded plaster frieze.
The ground floor front room has a fine carved wooden
chimneypiece with jasper lining (Plate 83). On the chimney breast
above is a circular plaque enclosing figure ornament and other
decorative plaster work. The side of the room facing the window is
treated as a segmental alcove, shown on the above plan, with coved
ceiling as shown on Plate 83.
The front room on the first floor has carved joinery to the
doors and windows, and the white and coloured marble
chimneypiece (Plate 84) is a good example of the period. The ceiling
of this room has a decorative plaster design with four oval figure
plaques.
The rear room on this floor has also good joinery, and a white
marble chimneypiece (Plate 84) with painted panels. The decorative
plaster ceiling (Plate 85) is ornamented with painted panels which,
according to the Rev. Lewis Gilbertson, the occupier, are the work of
Angelica Kauffmann.
Condition of repair.
The premises are in good repair.
Biographical notes.
The first occupant of the house was John Boddington, whose
residence there apparently lasted from 1780 to 1786, when he was
succeeded by Cuthbert Fisher, who stayed until 1799. In the latter year Mrs.
Bootle took the house.
The Council’s collection contains:—
[740]Ground and first floor plans (measured drawing).
[740]Chimney breast in front room on ground floor (photograph).
[740]Alcove in front room on ground floor (photograph).
General view of front room on first floor (photograph).

Ornamental plaster ceiling in front room on first floor (photograph).
[740]Marble chimneypiece in front room on first floor (photograph).
[740]Marble chimneypiece in rear room on first floor (photograph).
Detail of doorcase in rear room on first floor (photograph).

[740]Ornamental plaster ceiling with painted panels in rear room on
first floor (photograph).
LXXX.—No. 28, BEDFORD SQUARE.
Ground landlord, His Grace the Duke of Bedford, K.G.;
lessees, the Society of Architects.
structure.
On 1st November, 1776, a lease was granted[741] of a messuage
at the west end of Bedford Square, “on the south side of a new street
called Bedford Street” (now Bayley Street), having a frontage to the
square of 28¾ feet, and a depth of about 143 feet. The premises
referred to are obviously No. 28, the northernmost house of the west
block. The house has been greatly altered, and partly rebuilt. It
retains in the ground floor front room the original white marble
chimneypiece shown on Plate 86, with a sculptured panel in the
frieze, which is also shown to a larger scale.
The front room on the first floor contains a decorative plaster
ceiling, and a carved wood and composition chimneypiece, which,
though in keeping with the style of the room, is probably not
contemporary with the erection of the house.
Biographical notes.
The house first appears in the ratebook for 1779. Geo. Drake was then
the occupier and he continued to reside there until after 1800.
The Council’s collection contains:—
[742]Marble chimneypiece in front room on ground floor
(photograph).
[742]Detail of central panel of marble chimneypiece in front room on
ground floor (photograph).
Wood chimneypiece in front room on first floor (photograph).
LXXXI.—No. 30, BEDFORD SQUARE.
Ground landlord, His Grace the Duke of Bedford, K.G.; lessee,
the Russian Consulate-General.
structure.
On 1st November, 1776, a lease was granted[743] as from
Michaelmas, 1775, of “all that parcel of ground, with a messuage
thereon, on the west side of Bedford Square, being the third house
southward from Bedford Street,” now Bayley Street.
The front room on the ground floor has a chimneypiece of
white and coloured marble. The frieze is fluted, and contains
sculptured figures.
The front room on the first floor has its walls treated as large
panels, and over the two doors are decorative paintings. The chimney
piece is of white marble, and the flutings of the pilasters are inlaid
with coloured marble. The ornamental plaster ceiling (Plate 87) is of
very delicate design. The figures in the oval medallion are modelled
on classical lines, and in their delicacy are suggestive of cameos.
Biographical notes.
The occupiers of this house, according to the ratebooks, were:—
1778–79. Jas. Lee.

1779–93. Robt. Cooper Lee.
1793– Wm. Tatnell.

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7.2 What Determines How Fast Economies Grow? (pages 181–189)

 Labour productivity increases if there is an increase in the amount of capital available to

7.3 Economic Growth in Canada (pages 189–190)

7.4 Why Isn’t the Whole World Rich? (pages 191–200)

7.5 Growth Policies (pages 200–203)

Copyright © 2015 Pearson Canada Inc.

Copyright © 2015 Pearson Canada Inc.

A. Economic Growth from 1 000 000 BCE to the Present

B. Small Differences in Growth Rates Are Important

C. Why Do Growth Rates Matter?

D. “The Rich Get Richer and …”

Extra Solved Problem 7.1

Copyright © 2015 Pearson Canada Inc.

Solving the Problem

Estimated Real GDP for Canada

What Determines How Fast Economies Grow? (pages 181-189)

Copyright © 2015 Pearson Canada Inc.

A. The Per-Worker Production Function

B. Which Is More Important for Economic Growth: More Capital or Technological

C. Technological Change: The Key to Sustaining Economic Growth

D. New Growth Theory

2. Subsidizing research and development.

E. Joseph Schumpeter and Creative Destruction

Copyright © 2015 Pearson Canada Inc.

F. Thomas Malthus and Endogenous Population Growth

Economic Growth in Canada (pages 189-190)

A. Economic Growth in Canada since 1950

B. What Caused the Productivity Slowdown of 1973–1994?

C. Can Canada Maintain High Rates of Productivity Growth?

Extra Solved Problem 7.3

Copyright © 2015 Pearson Canada Inc.

Solving the Problem

Copyright © 2015 Pearson Canada Inc.

Why Isn’t the Whole World Rich? (pages 191-200)

A. Catch-up: Sometimes but Not Always

Copyright © 2015 Pearson Canada Inc.

C. Why Don’t More Low-Income Countries Experience Rapid Growth?

2. Wars and revolutions

3. Poor public education and health

4. Low rates of saving and investment

D. The Benefits of Globalization

7.5 Growth Policies (pages 200–203)

A. Enhancing Property Rights and the Rule of Law

B. Improving Health and Education

Copyright © 2015 Pearson Canada Inc.

C. Policies That Promote Technological Change

D. Policies That Promote Saving and Investment

E. Is Economic Growth Good or Bad?

Extra Solved Problem 7.5

 Subsidies for education

Copyright © 2015 Pearson Canada Inc.

Solving the Problem

Extra Economics in Your Life:

Copyright © 2015 Pearson Canada Inc.

Extra AN INSIDE LOOK News Article to Use in Class

SOLUTIONS TO END-OF-CHAPTER EXERCISES

What Determines How Fast Economies Grow?

Copyright © 2015 Pearson Canada Inc.

7.3 Economic Growth in Canada

Why Isn’t the Whole World Rich?

Copyright © 2015 Pearson Canada Inc.