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6 ECONOMIC
GROWTH**
China is the lowest, though recently China has been growing the most rapidly. China’s level of
income in 2016 is similar to that of Hong Kong in 1980.
2. Describe the sources of economic growth and identify the source of the growth slowdown.
Economic growth can be divided into two sources: Growth in work hours and growth in labor
productivity. Both sources contributed to the slowdown in economic growth in the 2000s. Growth
in work hours, after growing slowly between 1989 and 1999, disappeared in the 2000s and
contributed nothing to economic growth. Growth in productivity, while not totally disappearing,
slowed compared to previous eras. For both reasons, economic growth in the 2000s has been less
than during other periods.
3. Explain the influences on the pace of labor productivity growth.
Once the preconditions for growth are in place, the sources of labor productivity growth are:
physical capital growth, human capital growth, and advances in technology. All of these activities
enable an economy to grow and they all increase labor productivity. They all also interact: human
capital creates new technologies, which are then embodied in both new human capital and new
physical capital. Similarly advances in technology also lead to increases in labor productivity.
2. The IMF projects that China’s real GDP per person will be 57,163 yuan in 2017 and 60,334
yuan in 2018 and that India’s real GDP per person will be 98,028 rupees in 2017 and 104,191
rupees in 2018. By maintaining their current growth rates, which country will be first to
double its standard of living and when will that happen?
China’s growth rate of real GDP per person is [(60,334 yuan 57,163 yuan)/57,163 yuan] 100,
which is 5.5 percent. India’s growth rate of real GDP per person is [(104,191 rupees 98,028
rupees)/98,028 rupees] 100, which is 6.3 percent. China’s real GDP per person will double in
approximately 70/5.5 = 12.7 years and India’s real GDP per person will double in approximately
70/6.3 = 11.1 years, so India’s standard of living will double first in about the year 2029.
3. China was the largest economy for centuries because everyone had the same type of economy
—subsistence—and so the country with the most people was economically biggest. Then the
Industrial Revolution sent the West on a more prosperous path. Now the world is returning to
a common economy, this time technology- and information-based, so once again population
triumphs.
a. Why was China the world’s largest economy until 1890?
GDP equals GDP per person multiplied by the number of people. Until 1890 most people in the
world had approximately the same subsistence level of income so that every nation’s GDP per
person was about the same. Because China had, by far, the world’s largest population, China also
had the world’s largest GDP.
b. Why did the United States surpass China in 1890 to become the world’s largest economy?
The United States benefited from the industrial revolution that was sweeping Western nations at
the time while China did not. U.S. economic growth accelerated well beyond Chinese economic
growth so that the U.S. GDP became larger than China’s GDP.
Use the following tables to work Problems 4 to 6.
The first table describes an economy’s labor market in 2018 and the second table describes its production function in 2018.
Real wage rate Labor hours Labor hours Labor Real GDP
(dollars per hour) supplied demanded (hours) (2009 dollars)
80 45 5 5 425
70 40 10 10 800
60 35 15 15 1,125
50 30 20 20 1,400
40 25 25 25 1,625
30 20 30 30 1,800
20 15 35 35 1,925
40 2,000
4. What are the equilibrium real wage rate, the quantity of labor employed in 2018, labor
productivity, and potential GDP in 2018?
The equilibrium real wage rate is $40 per hour and the equilibrium quantity of labor employed is
25 hours. With employment of 25 hours, the production function shows that potential GDP is
$1,625. Labor productivity equals $1,625 25 hours, or $65.00 per hour.
5. In 2019, the population increases and labor hours supplied increase by 10 at each real wage
rate. What are the equilibrium real wage rate, labor productivity, and potential GDP in 2019?
The equilibrium real wage rate is $30 per hour and the equilibrium quantity of employment is 30
hours. With employment of 30 hours, the production function shows that real GDP is $1,800.
Labor productivity equals $1,800 30 hours, or $60.00 per hour.
6. In 2019, the population increases and labor hours supplied increase by 10 at each real wage
rate. Does the standard of living in this economy increase in 2019? Explain why or why not.
The standard of living does not increase. In fact, it decreases because real GDP per person falls.
The economy moves along its production function so that potential GDP increases but real GDP
per person decreases.
7. Labor Productivity on the Rise
The BLS reported the following data for the year ended March 2017: In the nonfarm sector,
output increased by 2.5 percent and labor productivity increased 1.2 percent. In the
manufacturing sector, output increased by 0.9 percent and labor productivity increased by 0.3
percent.
Source: bls.gov/news.release, June 5, 2017
In both sectors, output and labor productivity increased. Did the quantity of labor (aggregate
hours) increase or decrease? In which sector was the change in the quantity of labor larger?
Labor productivity equals real GDP divided by aggregate labor hours, so aggregate labor hours
equals real GDP divided by labor productivity. In terms of growth rates, this last formula means
that the growth in aggregate labor hours approximately equals the growth in real GDP minus the
growth in labor productivity. (This is the same calculation as on page 544 of the text for the
approximation formula for growth in real GDP per person.) Using this equation, in the nonfarm
sector labor hours rose by 2.5 percent – 1.2 percent = 1.3 percent and in the manufacturing sector
labor hours rose by 0.9 percent – 0.3 percent = 0.6 percent. The change in the quantity of labor
was the largest in the nonfarm sector.
8. Explain the processes that will bring the growth of real GD P per person to a stop according to
a. Classical growth theory.
According to the classical theory, population growth continues at a rapid pace as long as real GDP
per person exceeds the subsistence level. With population growth, the supply of labor increases
and diminishing returns lowers real GDP per person. Eventually real GDP per person equals the
subsistence amount, at which time economic growth ends.
b. Neoclassical growth theory.
In the neoclassical model, technological growth leads to increased saving so that capital
accumulates and real GDP per person grows. When technological growth stops, capital continues
to accumulate but diminishing marginal returns drives the return on capital lower and so decreases
investment and saving. Eventually the capital stock stops growing and economic growth stops.
c. New growth theory.
According to the new growth theory, economic growth will not stop.
10. Canada’s real GDP was $C1,830 billion in 2017 and $C1,866 billion in 2018. Canada’s
population was 36.7 million in 2017 and 37.1 million in 2018. Calculate
a. The growth rate of real GDP.
Between 2018 and 2017 this growth rate equals [($C1,866 billion $C1,830 billion)/$C1,830
billion] 100, which is 2.0 percent.
b. The growth rate of real GDP per person.
Canada’s population grew at [(37.1 million 36.7 million)/36.7 million] 100, which is 1.1
percent. Canada’s growth rate of real GDP is 2.0 percent, so the growth rate of real GDP per
person is 2.0 percent 1.1 percent, or 0.9 percent.
c. The approximate number of years it takes for real GDP per person in Canada to double if the
2018 growth rate of real GDP and the population growth rate are maintained.
Canada’s real GDP per person is growing at 0.9 percent a year. The rule of 70 tells us that
Canada’s real GDP per person will double in 70/0.9 = 77.8 years.
11. Australia’s real GDP was $A1,730 billion in 2017 and $A1,782 billion in 2018. Australia’s
population was 24.6 million in 2017 and 25.0 million in 2018. Calculate
a. The growth rate of real GDP.
The growth rate of real GDP between 2017 and 2018 is [($A1,782 billion $A1,730
billion)/$A1,730 billion] 100 = 3.01 percent.
b. The growth rate of real GDP per person.
Australia’s population growth rate is equal to [(25.0 million 24.6 million)/24.6 million] 100,
which is 1.63 percent. Australia’s economic growth rate is 3.01 percent, so the growth rate of real
GDP per person is 3.01 percent 1.63 percent, or 1.38 percent.
c. The approximate number of years it will take for real GDP per person in Australia to double
if the current real GDP and population growth rate maintained.
Australia’s real GDP per person is growing at 1.38 percent a year. The rule of 70 tells us that
Australia’s real GDP per person will double in 70/1.38 = 50.7 years.
12. A Shifting Global Economic Landscape
Global growth for 2016 is estimated at 3.1 percent. Advanced economies are projected to grow
by 1.9 percent in 2017 and 2.0 percent in 2018. The primary factor underlying the
strengthening global outlook over 2017–18 is the projected pickup in developing economies’
growth estimated at 4.1 percent in 2016, and projected to reach 4.5 percent for 2017. A further
pickup in growth to 4.8 percent is projected for 2018. Notably, the growth forecast for 2017
was revised up for China to 6.5 percent.
Source: International Monetary Fund, January 2017
Do the growth rates projected by the IMF indicate that gaps in real GDP per person around the
world are shrinking, growing, or staying the same? Explain.
The data in the news clip indicate that the gap in real GDP between the advanced economies and
the developing economies will decrease a bit in 2017 and 2018 because the developing economies
are projected to grow about 2.5 percentage points more rapidly than the advanced economies. As
long as the population in the developing economies grows less than 2.5 percentage points more
rapidly than growth in the advanced economies, the gap in real GDP per person will also shrink.
13. If a large increase in investment increases labor productivity, explain what happens to
a. Potential GDP.
The production function curve shifts upward and equilibrium employment increases, both of which
increase potential GDP.
b. Employment.
Employment increases. The demand for labor increases, which increases equilibrium employment.
c. The real wage rate.
The real wage rate rises. The demand for labor increases, which raises the equilibrium real wage
rate.
14. If a severe drought decreases labor productivity, explain what happens to
a. Potential GDP.
The production function curve shifts downward and equilibrium employment decreases, both of
which decrease potential GDP.
b. Employment.
Employment decreases. The demand for labor decreases, which decreases equilibrium
employment.
c. The real wage rate.
The real wage rate falls. The demand for labor decreases, which lowers the equilibrium real wage
rate.
Use the following tables to work Problems 15 to 17.
The first table describes an economy’s labor market in 2018 and the second table describes its production function in 2018.
Real wage rate Labor hours Labor hours Labor Real GDP
(dollars per hour) supplied demanded (hours) (2009 dollars)
80 55 15 15 1,425
70 50 20 20 1,800
60 45 25 25 2,125
50 40 30 30 2,400
40 35 35 35 2,625
30 30 40 40 2,800
20 25 45 45 2,925
50 3,000
15. What are the equilibrium real wage rate and the quantity of labor employed in 2018?
The equilibrium real wage rate is $40 per hour and the equilibrium quantity of labor employed is
35 hours.
16. What are labor productivity and potential GDP in 2018?
Potential GDP is $2,625, the quantity of real GDP produced with the equilibrium quantity of
employment. Labor productivity equals $2,625 35 hours, or $75.00 per hour.
17. Suppose that labor productivity increases in 2018.What effect does the increased labor
productivity have on the demand for labor, the supply of labor, potential GDP, and real GDP
per person?
The increase in labor productivity increases the demand for labor. The supply of labor does not
change. The equilibrium wage rate rises and equilibrium employment increases. Potential GDP
increases for two reasons: First, the increase in labor productivity increases potential GDP; second,
the increase in equilibrium employment increases potential GDP. Real GDP per person increases.
d. Why might work hours per person have decreased in both the United States and Canada, and
why might the U.S. decrease be greater than the Canadian decrease?
Recently the percentage of workers who work part-time has increased in both the United States
and Canada. The increase in the fraction of workers who are part time decreases the average work
hours per person. This decrease has been larger in the United States because the percentage of U.S.
workers who work part time has increased by more than in Canada.
e. What is the source of the United States’ faster productivity growth and what must Canada do
to replicate it?
The faster productivity growth in the United States is the result of U.S. adoption of more
productive technologies at a faster clip than Canada. Canada needs to increase the speed with
which it adopts better technologies. Canada might implement policies to increase saving, which
can be used to finance the acquisition and implementation of the new technologies.