GDP Growth Rates and Standard of Living

Production and Growth

• A country's standard of living depends on its ability to produce goods and services.
• Within a country, there are significant changes in the standard of living over time.
• In the US, average income (measured by real GDP per person) has grown by about 2 percent annually over the last century.

Productivity

• Productivity refers to the amount of goods and services produced per hour of a worker's time.
• A nation's standard of living is determined by the productivity of its workers.

The Variety of Growth Experiences

• Different countries have experienced vastly different growth rates over the period examined
• A table shows real GDP per person at the beginning and end of different periods for various nations, along with growth rates. (Specific data is contained in the table.)

Economic Growth Around the World

• Living standards, measured by real GDP per person, vary significantly among nations.
• The poorest countries have average income levels not seen in the United States for decades.

Compounding and the Rule of 70

• Annual growth rates, even small ones, become substantial when compounded over a long period.
• Compounding involves the accumulation of a growth rate over time.
• The Rule of 70 states that if something grows at a rate of x percent each year, it will double in approximately 70/x years. (e.g. an investment at 7% interest will double in 10 years).

Why Productivity Is So Important

• Productivity plays a crucial role in determining living standards for all nations.
• Productivity measures the quantity of goods and services a worker produces in an hour of work.

How Productivity Is Determined

• Productivity is determined by factors of production.

The Factors of Production

• Factors of production include physical capital, human capital, natural resources, and technological knowledge.
• Capital is a produced factor of production, an input into the production process which was previously an output of the production process.

Physical Capital

• Physical capital consists of equipment and structures used in producing goods and services.
• Examples include tools, machinery, buildings, and infrastructure.

Human Capital

• Human capital refers to the knowledge and skills workers acquire through education and experience.
• This includes training and knowledge gained.

Natural Resources

• Natural resources are inputs provided by nature, such as land, rivers, minerals, trees, forests.
• Some resources are renewable (e.g., trees), others are nonrenewable (e.g., oil, coal).
• Natural resources are important, but not essential, for high productivity.

Technological Knowledge

• Technological knowledge is the understanding of the best ways to produce goods and services.
• Human capital is crucial in disseminating this understanding among the workforce.

The Production Function

• Economists use production functions to represent the relationship between the quantity of inputs and the quantity of output from the production process.
• The general form of the production function is Y = A F(L, K, H, N). (More specific details on the function are given in the notes).
• The function demonstrates how inputs are combined to create outputs.
• A production function has constant returns to scale in instances where doubling inputs doubles the output produced.
• Productivity (Y/L) is determined by factors like physical capital (K/L), human capital (H/L), natural resources (N/L), and the state of technology (A) per worker.

Economic Growth and Public Policy

• Governments can implement various policies to increase productivity and living standards.

Government Policies That Raise Productivity and Living Standards

• Encourage saving and investment.
• Encourage investment from other countries.
• Encourage education and training.
• Establish secure property rights and maintain political stability.
• Promote free trade.
• Control population growth.
• Promote research and development.

The Importance of Saving and Investment

• Increasing future productivity involves investing more resources in capital production.
• Diminishing returns mean that increases in the saving rate translate to higher growth, only for a while.
• Higher saving rates in the long run increase income and productivity, but not their growth rate.
• The catch-up effect makes growth easier for countries starting out with lower levels of income.

Investment from Abroad

• Foreign investment helps increase capital accumulation and long-term economic growth.
• Foreign investment can come as direct investment (capital controlled and operated by another country's businesses) and portfolio investment (foreign money invested but managed by domestic entities)

Education

• Education is equally, if not more important to long-term growth, as investments in physical capital.
• Increased schooling raises wages, on average, by around 10% per US year.
• Providing access to education is crucial for governments aimed at raising living standards.
• Education leads to new, beneficial ideas that become part of society's pool of knowledge, thus providing further benefit to others.

Property Rights and Political Stability

• Property rights refer to the ability of individuals to control the resources they own.
• Respect for property rights is vital in order for a price system to work efficiently.
• Enforcing property rights is necessary to encourage investment.

Free Trade

• Trade acts like technology.
• Eliminating trade restrictions promotes faster economic growth, similar to major technological advancements.
• Inward-oriented trade policies avoid interacting with other countries, whereas outward-oriented trade policies encourage interaction.

Control of Population Growth

• A country's population influences its labor force.
• Larger populations typically lead to higher GDP.
• However, GDP per person is a more accurate indication of economic well-being, and rapid population growth can reduce it.

Research and Development

• Technological advancements increase living standards.
• Technological improvements predominantly emerge from private sector research by companies and individual inventors.
• Governments can spur innovation through research grants, tax breaks, and patent systems.

The Productivity Slowdown

• From 1959-73, productivity growth averaged 3.2 percent annually.
• From 1973-98, its growth slowed to 1.3 percent.
• This slowdown presents a major concern for policymakers.
• The slowdown likely results from less easily measured factors, such as changes in technology.

Test your knowledge about the factors affecting a country's standard of living and real GDP growth rates. This quiz covers essential economic principles including the rule of 70 and the impact of compounding on growth over time. Assess your understanding of various countries' economic performances as well.