Instructor's Manual 1
Chapter 1Economic Growth:
An Introduction to Scarcity and Choice
What's in This Chapter and Why
This chapter shows that the U.S. economy has the highest productivity and real wages among the large industrial countries. Productivity growth and real wage growth however are slower than in many other industrial countries and in the growing economies of East Asia.
Partly as a consequence of the rapid employment growth, productivity growth and real-wage growth have been slow. Part of the slow productivity growth has resulted from a slowing of technical change. Students may be surprised, however, to learn that productivity growth and technical change in the manufacturing sector increased rapidly in the 1980s.
The chapter points out that the United States is in control of its economic destiny. Individuals, of course, always have the option of saving and realizing a return to savings in the future. Similarly, as a society, we can increase our saving and investment. If we do, we will have more rapid productivity and wage growth in the future.
Some students will be surprised to learn that hourly productivity in the United States is much higher than in Japan. It is true that productivity growth is lower in the United States, but to a certain extent, it is natural that economies with lower productivity will have faster productivity growth than economies with higher productivity. The chapter states that there is no reason to think that productivity growth in other countries comes at the expense of productivity growth in the United States.
Finally, the chapter attempts to identify the factors that help developing countries grow.
Instructional Objectives
After completing this chapter, your students should know:
1.That productivity growth depends upon growth in the capital-labor ratio and technical change, which consists of technological improvement and efficiency improvement.
2.That productivity growth is the main determinant of real wage growth.
3.The reasons why productivity growth has declined in the United States and the prospects of growth with the “new economy.”
4.That productivity growth is lower in the United States than in many other advanced countries, but that productivity levels are higher.
5.That developing countries with a market orientation seem to be more successful in terms of economic growth.
6.That technology transfer helps developing countries grow, but faster population growth makes per capita economic growth difficult.
Key Terms
These terms are introduced in this chapter:
Instructor's Manual 1
Land
Labor
Physical capital
Human capital
Opportunity cost
Production possibilities curve
Best technology
Marginal cost
Scarcity
Marginal benefit
Marginal product
Technological improvement
Efficiency improvement
Capital intensity
Technical change
Suggestions for Teaching
In teaching this material, we like to challenge students' beliefs. For instance, some students believe that the U. S. economy has somehow become second rate. We show that this belief is wrong. For example, many students believe that Western Europe and Japan have more advanced economies. More rapid employment growth and a higher productivity level in the United States contradict their belief.
Additional References
In addition to the references in the text, instructors may wish to read or assign one or more of the following.
1."American Growth: More than Meets the Eye," The Economist 91 (December 26, 1992).
2.Barry Bosworth, George L. Perry, and Matthew D. Shapiro, "Productivity and Real Wages: Is there a Puzzle?" Brookings Papers on Economic Activity (1994), pp. 317-344.
3.Stanley Fischer, "Symposium on the Slowdown in Productivity Growth," The Journal of Economic Perspectives 2 (Fall 1988), pp. 3-97.
4.Charles R. Hulten, "Is the U.S. Economy in Decline?" The American Enterprise 1 (May/June 1990), pp. 62-69.
5.Paul Krugman, "The Myth of Asia's Miracle," Foreign Affairs 73 (November 1994), pp. 62-78.
6.Robert Samuelson, "The Rediscovery of the U.S. Economy," Newsweek 123 (February 28, 1994), p. 67.
7.Karl Zinsmeister, "Shadows on the Rising Sun," The American Enterprise 1 (May/June 1990), pp. 52-61.
Outline
I. RECENT GROWTH EXPERIENCES
A.Economic growth has a tremendous ability to raise living standards.
B.Since 1973, economic growth has slowed in high-income countries, but may have picked up in the United States after 1990.
C.GDP per capita in some countries may be catching up to that in the United States.
1.This has occurred because some countries have experienced economic growth rates significantly greater than that of the United States
D. Some countries are experiencing significant growth, but others appeared trapped at low growth rates. Considerations of the recent growth experiences in the selected countries raises at least three important questions:
1. What are the sources of economic growth in the United States and what are the prospects?
2. What are the similarities among countries that are successful in growth?
3. What are the similarities among countries that have failed to achieve steady economic growth?
II.SOURCES OF ECONOMIC GROWTH
A.Production Possibilities for the Economy
1.The economy uses resources to produce goods and services.
a.Land, labor, and capital (physical and human) are the three primary resources.
1.Land is all natural resources and raw materials.
2.Labor includes efforts and services of people in the production of goods and services.
3.Physical capital consists of durable produced goods used in the production process. Human capital consists of the knowledge and skills embodies in people, as applied to the production of goods and services.
2.A production possibilities curve shows the maximum combinations of two goods and services that an economy can produce when resources are fully used and the best technology is applied.
a.The best technology is the technology that requires the fewest resources to produce a given combination of goods and services.
b. The opportunity cost of gaining more of one kind of output is the value of what must be given up in order to obtain it.
B.The Best Combination of Goods and Services: Consumption vs. Growth
1.The best combination of goods and services is the combination that satisfies wants as fully as possible.
2.In order to achieve the best combination, the economy should produce at the point where marginal benefit and marginal cost are equal.
a.These values depend on both the amounts of goods and services sacrificed and gained and also on the values that individuals place on present and future consumption.
C.Resource Accumulation, Technological Improvement, and Efficiency Improvement
1.Economic growth, a rightward shift in the production possibilities curve, will occur if resources expand.
2.Technological progress, an improvement in the best technology that allows more output to be produced with a given amount of resources, will result in economic growth.
3.Efficiency improvement, a change from the use of less than the best to the best technology, results in an increase in output.
a.Unlike an expansion of resources and technological progress, technical efficiency improvement moves an economy from a point inside the production possibilities curve to a point on the curve. The curve does not shift.
D.The Importance of Productivity Growth
1.Productivity growth is important because it determines how fast compensation per hour can grow.
2.From 1960 to 1973, real output per hour grew by about 3 percent per year. From 1973 to 1990, it grew by about 1.3 percent per year. Over these periods, compensation per hour grew at about the same rate as output per hour–hence their close correspondence.
3.Since 1990, productivity and thus compensation have grown faster–at 2 percent annual rate. Some observers believe that the more rapid growth suggests that we are in a “new economy” and expect a long period of rapid economic growth.
III. PRODUCTIVITY GROWTH: WHAT CAN WE EXPECT IN THE “NEW ECONOMY”?
A.The Contribution of Capital Intensity Growth: The New Economy?
1.From 1995 to 1999, the use of information technology (IT) grew at almost 20 percent per year, while non-IT capital services grew at 3 percent a year, and labor services grew at about 2 percent.
2.These growth rates imply an increase in capital intensity, and specifically, IT capital intensity.
3.Experts conclude that labor productivity has grown faster in the 1990s because of technical change contribution.
B.The Contribution of Technical Change: The New Economy?
1.Changes in labor productivity growth caused by fluctuations in technical change limited our prosperity from the 1970s through early 1990s and may have enhanced it since then.
2.Technical change is more than scientific and engineering advances. It is anything that increases output from a fixed amount of resources.
3.By the mid 1980s the IT revolution probably begun a new wave of economic progress introducing new technologies and discarding old ones. These new technologies have their impacts over a long period of time, hence the impact of rapid technical change of mid 1990s may be yet to come.
4.The technological advances in the IT sector and build up in IT assets have played a role in productivity acceleration. However, retail, banking, and hotel sectors have invested heavily in IT but are not realizing productivity benefits.
5.The prospects are encouraging, but the existence of the new technology is not sufficient to guarantee the results.
IV. ECONOMIC AND PRODUCTIVITY GROWTH IN VARIOUS PARTS OF THE WORLD
A.Growth in Europe and Japan: Catching Up
1.Other countries have converged rapidly towards productivity levels in the United States because they have had a more rapid growth rate in capital intensity.
a.Fast employment growth in the United States has led to a slower growth rate of capital intensity.
b.More rapid investment can help the United States maintain both a rising standard of living and its leading position in productivity.
2.Both Germany and Japan get a greater boost to labor productivity growth from technical change than does the United States.
a.Structural effects help to account for differences in technical change in the United States and technical change in Germany and Japan.
1.The large shifts in economic activity away from the agricultural industry in Germany and Japan have tended to raise overall productivity.
b.Technological diffusion or catch-up effects help to account for differences in technical change in the United States and technical change in Germany and Japan.
1.Technology transfer from the United States to Germany and Japan has also increased their productivity growth.
c.The foreign trade effect helps to account for differences in technical change in the United States and technical change in Germany and Japan.
1.Free trade after World War II gave an advantage to follower countries because it increased competition in smaller economies where monopolies once flourished and because it allowed smaller countries to take advantage of large size.
B.Developing Countries after 1950: Some Grow. Some Don’t.
1.Korea and Taiwan have moved well ahead of many African and Latin American countries in terms of income growth since 1950.
2. Those countries with the most success at catching up with the United States since 1950 have place emphasis on an educated work force and investment in human and physical capital; moreover, they are open to foreign influences.
3.Compared with the past, developing countries may have a disadvantage in experiencing rapid economic growth.
a.Economic growth requires that either a) labor grow faster than the population, b) capital grow faster than labor, or c) technical change. Population growth in developing countries (caused by improved health care), makes it more difficult to fulfill the first two requirements for economic growth.
4.In the area of technical change, developing countries may have an advantage relative to the past.
a.They must simply adapt technology to their economies rather than develop it.
Answers to Review Questions
1.Compare the economic growth of Japan, Korea, and the United States since 1960.
Since 1820, the United States has had a lower growth rate than Japan. The annual growth rate of the United States over this period was about 1.6 percent. Japan, on the other hand, experienced annual growth rates of about 1.9 percent. This may seem like a small difference, but in 1820, per capita income in the U.S. was 100 percent greater than in Japan; in 1992, it was only 16 percent greater. Since 1960, the U.S. has had an average annual growth rate of 1.9 percent while Japan’s average annual growth rate has been over 4 percent. Korea has had an average annual growth rate of over 6 percent.
It should further be noted that since 1973, growth rates in both the United States and Japan have declined significantly. Korea’s growth rates have declined slightly. Both Korea and Japan experienced rapid growth from 1960 through 1990, which caused the absolute income gap between these countries and the U.S. to narrow substantially. Since 1990, the Japanese economy has stagnated, and Korea suffered from economic crises in the late 1990s. The result is that the United States’ advantage in terms of absolute income is again growing.
2.Define each of the following terms:
a. production possibilities curve.
b. technological improvement
c. efficiency improvement
a.A production possibilities curve is a curve showing the maximum combinations of two goods (or services) that can be produced by an economy when its resources are fully employed and the best technology is used.
b.Technological improvement is an improvement in the best technology that allows more to be produced with a given amount of resources. The best technology is the technology that requires the fewest resources to produce a given combination of goods and services.
c.Efficiency improvement is a change from the use of less than the best technology to the best technology. It allows more output to be produced with the same resources.
3.Is a faster rate of economic growth always desirable? Explain carefully using the production possibilities curve.
A faster rate of economic growth is not always desirable. One way economic growth occurs is through an increase in capital resources. This occurs as more capital goods are produced. It is only desirable to increase the production of capital goods, if the marginal benefit of increased production outweighs the marginal cost. This is illustrated in the following example.
Note that two goods, robots (a capital good) and coffee (a consumption good), are produced. Suppose the economy is currently operating at point A where 100 robots and 300 pounds of coffee are being produced. In order to produce one more robot, the economy must move from point A to point B. This requires that 10 pounds of coffee be given up. Thus, the marginal cost of the robot is the value of the 10 pounds of coffee. The marginal benefit of the robot is the value of increased coffee production that can be produced in the future because more capital equipment will be available in the future.
If the marginal benefit of the robot exceeds the marginal cost, it pays to move from point A to point B. On the other hand, if the marginal cost (the consumption we give up in the present) exceeds the marginal benefit (the value of future consumption) we should not move from A to B. In this case, a faster rate of economic growth would not be desirable. These values will depend on both the amounts of goods and services sacrificed and gained as well as on the values that individuals place on present and future consumption.
4.Use the accompanying graph to answer questions a through d.
a.What point would represent a combination of goods and services that cannot be produced with the economy's given resources and technology?
b.What point would represent a combination of goods and services that might be produced if the economy were experiencing unemployment? What else could cause the economy to be at that point?
c.Suppose the economy is currently producing at point C and would like to have the consumption goods represented by point D. What must be given up to obtain the increased consumption goods?
d.Suppose the economy is at point D. What might be done to increase the chances of being at B next year? What are other ways to get to B?
a.Any point, such as point B, which lies beyond the boundary of the production possibilities curve represents a combination of goods and services that cannot not be produced with the economy's given resources and technology.
b.Any point within the boundary of the production possibilities curve, such as point A, would represent a combination of goods and services that might be produced if the economy were suffering from unemployment. Anytime the economy is not using the best technology or resources are not fully employed, the economy will be operating at a point inside the production possibilities curve.
c.If the economy is at point C, it is producing 10 million units of capital goods and 100 million units of consumption goods. If the economy moves to point D, it will produce 80 million units of capital goods and 120 million units of consumption goods. To increase the production of consumption goods by 20 million units, 2 million units of capital goods must be given up.
d.One thing that can be done to increase the chances of being at point B next year is to decrease the production of consumption goods and increase the production of capital goods. As a result, capital resources will grow, and the production possibilities curve will shift out. In addition, improvements in technology will also shift the production possibilities curve. As improvements in the economy's best technology improve, the chances of reaching point B will be enhanced.
5.Why did compensation per hour not grow as fast after 1973 as it did from 1960 to 1973?
Growth in productivity, output per hour, limits how fast compensation per hour can grow. From 1960 to 1973, real output per hour grew about 2.5 percent per year. After 1973, it grew by less than 1 percent per year. Compensation per hour grew at about the same rate as productivity. From 1960 to 1973, real compensation per hour grew at an annual rate of 2.5 percent. Compensation growth, mirroring growth in productivity, collapsed to about 0.8 percent per year after 1973.