Topic 1: Introduction & Patterns of Economic Growth

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1 GDP Tpic 1: Intrductin & Patterns f Ecnmic Grwth The market value f the final gds and services prduced in an ecnmy ver a certain perid. Measured in $ terms and NOT quantity Final gds and services (nt intermediary prducts ie flur) Have t be prduced in a specific perid Only includes gds and services that transact in markets. Ie putting a child in a day care cunts, but a stay at hme mum lking after her wn children des nt. Limitatins Des nt incrprate the changes in health Des nt include changes in envirnmental resurces ie air and water pllutin generated by factries as by-prducts f their manufacturing d nt reduce GDP. GDP des nt decrease when nn-renewable natural resurces ie natural gas and il are extracted depleting il and natural gas reserves Measures f GDP Prductin Measure Cunts the number f gds prduced (new, nt used) in the ecnmy. Des nt include intermediary prducts ie if a steel cmpany prduced $10 wrth f steel which is then sued by autmbile cmpany t make $100 wrth f trucks then GDP = $100. The steel cmpany prduced $10 f GDP, while the autmbile cmpany nly prduced $90 wrth f GDP ($100-$90) Ie Hmer and Marge have a fruit farm with a small fruit stand in the frnt yard. GDP here is the ttal number f tangerines Hmer and Marge prduce in a year Expenditure Measure Cunts the ttal purchases in the ecnmy. Ie fcusing n sales at the fruit stand Cnsumers visit the stand each day t buy tangerines, and the ttal purchases represent the expenditure apprach t measuring GDP Y = C + I + G + NX Incme Measure Adds up all the incme earned in the ecnmy. Ie the wrkers are paid a wage and Marge and Hmer earn sme incme (the prfits that are nt paid ut as wages t the wrkers). Hence all prductin gets paid ut t smene as incme either t the wrkers as wages r t Hmer and Marge as prfit GDP is equal t the value f all gds and services prduced in the ecnmy, but it is als equal t the sum f all incme earned in the ecnmy. This is as fr every dllar f prduct sld there is a dllar f incme earned. PRODUCTION = EXPENDITURE = INCOME

2 Measuring Changes Over Time Nminal GDP refers t a measure f GDP when prices and quantities have nt been separated measured in current dllars. Real GDP refers t the actual quantity f gds and services, adjusted fr inflatin measured in certain year s dllars. Ie 2020 quantity in 2019 prices ie if an ecnmy prduces 37 cell phnes at $100 each, then nminal GDP wuld equal $3,700 while real GDP wuld equal 37 cell phnes Always calculate in REAL GDP nt NOMINAL GDP EXAMPLE 1: If the quantity f gds and services prduced des nt change, but prices d change Nminal GDP will change. Real GDP will nt change. Ie Suppse that in 2018, an apple csts $1, a cmputer csts $900, and the ecnmy prduces 500 apples and 5 cmputers. Then nminal GDP in this ecnmy is $5,000. Nw suppse that in 2019, the ecnmy still prduces 500 apples and 5 cmputers, but an apple nw csts $2 while a cmputer csts $1,000. Nminal GDP in 2009 is then $6,000. Nminal GDP is higher by $1,000 in 2019, but we knw that nthing real has changed: the ecnmy is prducing the same number f apples and cmputers. Here, all the change in nminal GDP ccurs because f changes in prices. In rder t cntrl the change in price that ccurred frm 2018 t 2019, we must use the same set f prices t cmpute real GDP in the each f the tw years either the 2018 prices r the 2019 prices. If we use 2019 prices, GDP will measure t be $6000 in bth years. If we use 2018 prices, GDP will measure as $5,000 in bth years. Bth appraches state that real GDP is unchanged. EXAMPLE 2: where real GDP changes Ie Suppse that in 2020, an apple csts $3, a cmputer $1000 and the ecnmy prduces 550 apples and 6 cmputers. $3/Apple x $1000/cmputer x 6 = $7650 Therefre, nminal GDP is $7650 Hwever, relative t 2019 prices abve we knw that in 2020 the ecnmy is prducing 50 mre apples and 1 mre cmputer. By using 2019 prices we can find real GDP f 2020: (2020 quantity in 2009 prices)

3 Price Indexes & Inflatin The GDP deflatr is the price level that satisfies the equatin: Nminal GDP = price level x real GDP. We culd cmpute this frmula fr tw different years t calculate a price change. The inflatin rate is the percentage change in the price level. Cmparing GDP acrss Cuntries The exchange rate is the price at which different currencies are traded. T make cmparisns f GDP acrss cuntries we must take the fllwing tw steps: 1. GDP must be adjusted by the exchange rate s that GDP is expressed in a cmmn currency. Use the exchange rate t turn Australian dllars int U.S. dllars. US$1 AU$ 26.4 trillin = US$25.9 trillin AU$ Nminal GDP must then be multiplied by the price level f the tw different cuntries USD Price level Real GDP US USD = x Nm GDP Price level USD USD Nm GDP Real GDP = Price levelus x Price level In general, rich cuntries tend t have higher price levels than pr cuntries. This is mainly because pr cuntries have lwer wages. Ecnmic Grwth Grwth is a lng run phenmenn. Sustained increases in standards f living are a recent phenmenn. Mdern ecnmic grwth nly emerged in the mst recent tw r three centuries. (after industrial revlutin?) Sustained ecnmic grwth emerges in different places at different times.

4 Figure 3.1 shws estimates f per capita GDP ver the last 2,000 years fr six cuntries. Fr mst f histry, standards f living were extremely lw, nt much different frm that in Ethipia tday. The figure shws this ging back fr 2,000 years, but it is surely true ging back even farther. Since 1700, living standards in the richest cuntries have risen frm rughly $500 per persn t smething appraching $45,000 per persn tday. On a lng-time scale, ecnmic grwth is s recent that a plt f per capita GDP lks like a hckey stick, and the lines fr different cuntries are hard t distinguish. Grwth first starts t appear in the United Kingdm and then in the United States. Standards f living in Brazil and Japan begin t rise mainly in the last century r s, and in China nly during the last several decades. Finally, standards f living in Ethipia tday are perhaps nly twice as high as they were ver mst f histry, and sustained grwth is nt especially evident. Per capita GDP living standards differ remarkably arund the wrld. The Great Divergence is the era f increased difference in standards f living acrss cuntries. Rich getting richer. Befre 1700, natins differed nly by a factr f tw r three, while tday it is ver a factr f 50 fr several cuntries. Frm 1870 t 2000: United States per capita GDP rse by nearly 15-fld. Australia per capita GDP rse by nearly 8-fld. Definitin f Ecnmic Grwth The exact rate f change f per capita real GDP Percentage Change: The change between tw perids divided by the value f the variable in the initial perid. It is this percentage change which is called the grwth rate Percentage change in GDP between perid t and t + 1 (which equals the grwth rate): T find the grwth rate between that same perid: the level f per capita incme next year is equal t per capita incme this year times the bracketed quantity (1 plus the grwth rate). Allws us t determine the value f per capita incme tmrrw if we knw the value tday and the grwth rate

5 Calculating Incme and Grwth rates The rule fr cmputing grwth rates: (see pg 47) Where Y 0 is an initial value and is the cnstant grwth rate and the value f the variable at sme future time is t This frmula can still be applied even if the data des nt exhibit cnstant grwth by: Rule f 70 and the Rati Scale The Rule f 70 says that if y t grws at a rate f g percent per year, then the number f years it takes y t t duble is apprximately equal t 70/g. Ie a grwth rate f 10% will take 7 years t duble their incme (70/10) If a cuntry s incme grws at 1 percent per year, then it takes abut 70 years fr incme t duble. On the ther hand, if grwth is slightly faster at 5 percent per year, then incme dubles every 14 (70/5) years. Seemingly small differences in grwth rates lead t quite different utcmes when cmpunded ver time Hwever the time that it takes fr incme t duble depends nly n the grwth rate, nt n the current level f incme. If a cuntry s incme grws at 2 percent per year, then it dubles every 35 years, regardless f whether the initial incme is $500 r $25,000 A rati scale (als ften referred t as a lg scale) is a plt where equally spaced tick marks n the vertical axis are labeled cnsecutively with numbers that exhibit a cnstant rati (i.e., a rati f 2 indicates that each tick mark dubles frm the previus). When pltted n a rati scale, a variable that grws at a cnstant rate will be a straight line. This is useful as we can linearise the scale and we can als remve the flat-then-steep. Ie instead f the labelling the vertical axis as 1, 2, 3, 4 we label it as 1, 2, 4, 8 r 6, 12, 24, 48 s that each interval represents a dubling The left graph shws ppulatin increasing expnentially, but it is hard t see the grwth rate. The right graphs shws a cnstant grwth rate f ppulatin. Abslute ppulatin numbers are increasing faster, but the rate f grwth is staying the same in the right graph because f the linear relatinship.

6 If incme is grwing at a cnstant rate it will be a straight line n a rati scale; but if grwth rates are rising, the slpe will be increasing. When pltted n a rati scale, it is easy t see that per capita GDP in the United States has grwn at apprximately 2 percent per year ver the last 130 years. Figure 3.5 shws the same data as Figure 3.2, per capita GDP in the United States, but nw n a rati scale. Ntice that the vertical axis here is labeled 2, 4, 8, 16 dubling ver equally spaced intervals. Quite remarkably, the data series lies clse t a line that exhibits a cnstant slpe f 2.0 percent per year. This means that t a first apprximatin, per capita GDP in the United States has been grwing at a relatively cnstant annual rate f 2.0 percent ver the last 140 years When cmparing levels f incme n a rati scale, recall that data pints that are half belw anther cuntry are actually much lwer because the numbers n the vertical axis duble. Incme levels in Germany and Japan have cnverged t the level in the United Kingdm during the pstwar perid. Ecnmic grwth in Brazil shws a different pattern, ne that, t make a vast and smewhat unfair generalizatin, is mre typical f grwth in Latin America. Between 1900 and 1980, the cuntry exhibited substantial ecnmic grwth, with incme reaching nearly 1/3 the U.S. level. Since 1980, hwever, grwth has slwed cnsiderably, s that by 2006 incme relative t the United States was just ver 1/5. China shws smething f the ppsite pattern, with grwth really picking up after 1978 and reaching rates f mre than 7 percent per year fr the last tw decades. A cuntry ften gruped with China in such discussins is India, in part because the tw cuntries tgether accunt fr mre than 40 percent f the wrld s ppulatin. By 2006, China s per capita incme was abut 1/5 the U.S. level, while India s was just under 1/12. These last numbers may cme as a surprise if yu take nly a casual glance at Figure 3.6; at first it appears that by 2006 China s incme was mre than half the U.S. level. But remember that the graph is pltted n a rati scale: lk at the crrespnding numbers n the vertical axis. After Wrld War II, grwth in Germany and Japan accelerated. Cnvergence prer cuntries will grw faster t catch up t the level f incme in richer cuntries. Brazil had accelerated grwth until 1980 and then stagnated, while China and India have had the reverse pattern.

7 The hrizntal axis represents per capita GDP in the year 2007 relative t the United States. The vertical axis illustrates the wide range f grwth rates that cuntries have experienced since Hng Kng, Nrway, Singapre, and the United States had the highest per capita GDP in the wrld that year. Other rich cuntries include Ireland, Israel, Japan, Suth Krea, and Spain, with incmes greater than 1/2 the U.S. level. Middle-incme cuntries like Hnduras, Mexic, and Argentina had incmes abut 1/3 the U.S. level. China, India, and Indnesia are examples f cuntries with relative incmes between 1/16 and 1/5. Burundi, Niger, and Tanzania, amng the prest cuntries f the wrld in 2007, had incmes as lw as 1/64 the U.S. level. The fastest-grwing cuntries ver this perid include Suth Krea, Hng Kng, Thailand, China, Btswana, and Japan, all with average grwth rates between 4 and 6 percent per year. At the ther end f the spectrum are the Central African Republic, the Demcratic Republic f the Cng, Niger, and Zimbabwe, each f which exhibited negative average grwth ver this half century. The bulk f the cuntries lie between these tw extremes. In Taiwan, fr example, which is grwing at 6 percent per year, incmes will duble every 12 years Grwth rates between 1960 and 2007 range frm 23 percent t 16 percent per year. Per capita GDP in 2007 varies by abut a factr f 64 acrss cuntries. The perid Sme cuntries have exhibited a negative grwth rate. Other cuntries have sustained nearly 6 percent grwth. Mst cuntries have sustained abut 2 percent grwth. Since 1960: The bulk f the wrld s ppulatin is substantially richer. The fractin f peple living in pverty has fallen. Reasn fr change: Ecnmic grwth in China and India wh are 40% f the wrld s ppulatin The graph shws, fr 1960 and 2010, the percentage f the wrld s ppulatin living in cuntries with a per capita GDP less than r equal t the number n the hrizntal axis. This per capita GDP is relative t the United States in the year 2010 fr bth lines.

8 Prperties f Grwth Rates Suppse tw variables x and y have average annual grwth rates f g x and g y, respectively. Assume als that g z is the average annual grwth rate f z. Then the fllwing rules apply: Examples f Grwth Rate Calculatins Suppse x grws at rate g x = 0.10 and y grws at rate g y = 0.03 what is the grwth rate f z in the fllw cases? Z = x X y g z = g x + g y = 0.13 Z = x/y g z = g x g y = 0.07 Z = y/x g z = g y g x = Z = x 2 g z = 2 x g x = 0.20 Z = y 1/2 g z = 0.5 x g y = Z = x 1/2 y -1/4 g z = 0.5 x g x 0.25 x g y = Example 1: Y t = A t K t 1/3 L t 2/3 g(y t ) = g(a t ) + g(k t 1/3 ) + g(l t 2/3 ) g(y t ) = g(a t ) + 1/3 x g(k t ) + 2/3 x g(l t ) Benefits & Csts f Ecnmic Grwth Benefits Imprvements in health (ie increased life expectancy, reductin in infant mrtality) Higher incmes (standard f living) Increase in the variety f gds and services Csts Envirnmental prblems (ie pllutin, depletin f natural resurces, glbal warming) Incme inequality acrss and within cuntries Lss f certain types f jbs due t technlgical advances Ecnmists generally have a cnsensus that the benefits f ecnmic grwth utweigh the csts.