Keynesian Income and Expenditure Model 1

Keynesian Income and Expenditure Model

• Long-run economic growth is measured by increases in real GDP per capita
• Focus is placed on how real GDP per capita changes over time across different countries
• Productivity is a key factor the drive economic growth long term
• Growth is tied to physical capital, human capital, and technological progress
• Differing long-run growth rates are seen in many countries

Economic Growth in the US

• Aims to discover how much the US economy has grown over time
• Analysis of current gaps between wealthy and developing countries
• Real GDP per capita is vital to these considerations

Growth in India and China Since 1980

• India and China have experienced greater economic growth rates than the US since 1980
• China reached the US's 1900 standard of living in 2008
• India's standard of living as of 2018 remained below that of the US in 1900

Real GDP per Capita Examples

• The US's economic growth over the last century is measured by real GDP per capita
• Increases in percentage attributed to inflation, and other calculations

Income Differences

• Some nations have had stalled growth, while the US and others have grown quickly
• Around 25% of the global population has a lower living standard now than the US in 1900

How the US Reached High Production

• The US produced eight times more real GDP per capita in 2018 than in 1900 due to economic growth
• There is gradual progress of a few percent per year for real GDP per capita
• The Rule of 70 can assess economic growth

Rule of 70

• Use the following formula
• Doubling time for X = 70 / Annual growth rate of X
• If real GDP per capita grows at 3.5% annually, it doubles in 20 years using the rule
• Compounding allows small growth improvements to add up quickly

Growth Rate Differences

• The average rate of real GDP per capita from 1980-2021 is examined
• China, India, and Ireland achieved substantial growth
• The U.S. and France experienced moderate growth, while Argentina's growth was sluggish, and Zimbabwe slid backward

Practice Question 1

• Calculating how long it will take for an average person in India to match the wealth of an average Western European, accounting for inflation:
  • India's real GDP per capita is $3,000
  • The real output per person grows at 5% per year
  • The calculation will show how many years until India reaches current Italian standards of $24,000 per year

Practice Question 2

• Calculating India's real GDP per worker doubling in 50 years with The Rule of 70:
  • Determine India's annual growth rate
  • Determine what the annual growth rate would be if real GDP per worker quadrupled in 50 years

Long-Run Growth Sources

• Rising productivity determines long-run economic growth
• Labor productivity, or productivity, measures output per worker
• Productivity is real GDP (y) divided by the number of workers (L)

Explaining Worker Productivity

• Today's average worker produces more than a century ago, due to
  • More physical capital
  • Higher education rates
  • Technological progress
• Productivity growth comes from three sources:
  • Increased physical capital: buildings and machines as human-made resources
  • Increased human capital: workforce knowledge
  • Technological progress: advance in production

Aggregate Production Function

• The function answers by how much output changes when K, H, and T are changed?
• The aggregate production function is hypothetical
• Shows productivity (real GDP per capita = y/L) with these factors:
  • Physical capital per worker (K/L)
  • Human capital per worker (H/L)
  • Technology (T)

Aggregate Production Function and Diminishing Returns

• The aggregate production function exhibits diminishing returns to physical capital when H/L and T are fixed
• Each successive increase in K/L leads to a smaller productivity increase/worker (y/L)
• A second computer improves productivity, but not as much as the first computer did

Remembering Diminishing Returns

• Diminishing returns is based on the equal phenomenon concept
• Diminishing returns may disappear if H/L increases or T improves
• All productivity factors increase over time, with
  • Increased K/L and H/L
  • Technological progress

Growth Accounting

• All factors that add to productivity, such as K/L, H/L, and T, rise during economic growth
• The effects of each factor on productivity can be estimated
• Estimates of major factors in the aggregate production contribute to economic growth
• The goal is to differentiate the impact of each factor

Real GDP Analysis

• Over time, K/L increases, which results in higher y/L
• Technological advancements, denoted as T, also impact the economy, shifting from A to D and boosting y/L
• Increasing capital per worker increases real GDP per worker
• Higher total factor productivity accounts for 50% of the increase in y/L

Total Factor Productivity

• Describes the total value of inputs that can be produced from given amounts of factor inputs
• Increased total factor productivity leads to an increase of the economy's ability to produce higher outputs with the same factor quantities, K, H, and L

Role of Technology

• Technological progress enables increased productivity and an upward-shifted aggregate production (y/L) function
• Technological progress increases total factor productivity

Economic Growth and Total Factor Productivity

• Economic growth depends on increasing total factor productivity
• The BLS finds that US labor productivity rose 2.1% annually from 1948 to 2022
• Growing total factor productivity and technological advancements account for the rest
• Increases in K/L and H/L explain 49% of the rise

Influence of Natural Resources

• Natural resources exert influence productivity, as they are considered less important modernly
• Very high real GDP per capita, despite Japan's very few natural resources
• Nigeria is a resource-rich nation, yet has a low real GDP per capita

Economies with Rapid Growth

• Economies with rapid growth:
  • Rapidly increase their investment in savings and contribute to their capital
  • Improve their education to increase human capital
  • Research and development helps to improve technology

The Impact of Capital Investment

• Higher economic growth comes from high rates of capital investment
  • Japan in the 1960s, was the fastest-growing major economy
  • They spent a high share of its GDP on investment goods compared to other similar economies
  • China's GDP investment in 2021 was 42%

Investment Money

• High investment expenditure comes from savings, including:
  • Savings from domestic households
  • Savings from foreign households as foreign investment

Connection Between Education and Financial Success

• Education spending correlates to a population:
  • Higher levels of human capital
  • Higher rates of success

China's Education

• China's adding human capital correlates to long term success politically, economically, and socially

Importance of Research and Development

• New technologies need to be developed to improve production for further economic growth
• Research and Development refers to spending on these new technologies
• All of the R&D mentioned is usually funded by the government or is privatized by firms

Government and Economic Growth

• Government can increase the growth rate of the overall economy
• Six channels can generally promote investment in K and H and lead to higher rates of long-run economic growth, including:
  • Government subsidies to infrastructure
  • Infrastructure being: roads, power lines, ports, and information networks.
  • Government subsidies to education
  • Government subsidies to R&D
  • Maintaining a well-functioning financial system
  • People invest in safe financial systems to productively spend

Property Rights as Investments

• Governments protect innovations in property rights
  • Intellectual property rights allow innovators to accrue rewards
  • Patents prevent temporary monopolies of innovator sales

Political Stability

• Riot risks in a location can result in a lack of productive investment
• Economic success requires:
  • Good laws
  • Institutions that enforce laws
  • A stable political system