Econ 2 CHAPTER 17 Essay

CHAPTER 17
Economic Growth: Resources, Technology, Ideas, and Institutions
Chapters 8 through 10 developed the aggregate supply-aggregate demand model to study fluctuations in Real GDP around the natural rate. Both the production possibilities curve and the long-run aggregate supply curve were assumed to be fixed. However, experience shows that these curves are not fixed. In the long run, the standard of living depends more on creating economic growth and shifting the production possibilities frontier and long-run aggregate supply curves rightward than upon minimizing fluctuations around these curves. Chapter 17 looks at how economic growth can occur and explains what can cause a rightward shift in the production possibilities frontier or the long-run aggregate supply curve.
 KEY IDEAS
1.
2.
3.

Economic growth rates matter.
Several factors cause economic growth.
Two theories about economic growth are the neoclassical growth theory and the new growth theory.

 CHAPTER OUTLINE
I.

A FEW BASICS ABOUT ECONOMIC GROWTH
Economic growth refers to either absolute real economic growth or to per capita real economic growth. Absolute real economic growth is an increase in Real
GDP from one period to the next. Per-capita real economic growth is an increase in per-capita Real GDP from one period to the next where
Per-capita Real GDP = Real GDP/Population
A.

Do Economic Growth Rates Matter?
Economic growth rates matter because, if they are sustained over a long period of time, people will see a real difference in their standard of living.

II.

A PRODUCTION FUNCTION AND ECONOMIC GROWTH
A production function specifies the relation between technology and the quantity of factor inputs to output or Real GDP. In the following production function, T stands for technology, L stands for labor, and K stands for capital:
Real GDP = T(L,K).

If any of these factors increase, Real GDP will increase.
A.

The Graphical Representation of the Production Function
Exhibit 2 in the text shows a graphical representation of the production function, and shows that a change in labor moves us along an existing production function, while a change in capital or technology will shift the production function.

B.

From the Production Function to the LRAS Curve
Changes in and movements along the production function can be linked to shifts in the LRAS curve. This is shown in Exhibit 3.

C.

Emphasis on Labor
Marginal income tax rate cuts induce workers to work more, and, as they work more, the LRAS curve will shift rightward.

D.

Emphasis on Capital
A decrease in taxes on capital returns causes more capital to be utilized in the production process, thus shifting the production function upward and thereby shifting the LRAS curve rightward. A decrease in interest rates prompts firms to borrow more in order to purchase capital goods. As they buy and utilize more capital, the production function shifts upward and the
LRAS curve shifts rightward.

E.
Capital

Emphasis on Other Resources: Natural Resources and Human

A more fully specified production function would also include natural resources (NR) and human capital (H). The resource land is another name for natural resources. Human capital is the knowledge and skills a person acquires through education, training, and experience. It is different from physical capital, the capital referred to earlier.
F.

Emphasis on the Technology Coefficient and Ideas
New growth theory puts more attention on technology, ideas, institutions, and education than did neoclassical growth theory. Neoclassical growth theory emphasized labor and physical capital, while assuming that technology was outside of our control. New growth theory holds that technology is endogenous; it is a central part of the economic system.
More important: the more resources that go to develop technology, the more and better technology that is developed.

Paul Romer, whose name is synonymous with new growth theory, believes that if one person is trying to

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