8
Why Do
Economies Grow?
Chapter Summary
In this chapter, we explored the mechanisms of economic growth. Although economists do not have a complete understanding of what leads to growth, they regard increases in capital per worker, technological progress, human capital, and governmental institutions as key factors. Here are the main points of the chapter:
• Per capita, GDP varies greatly throughout the world. There is debate about whether poorer countries in the world are converging in per capita incomes to richer countries.
• Economies grow through two basic mechanisms: capital deepening and technological progress.
Capital deepening is an increase in capital per worker. Technological progress is an increase in output with no additional increases in inputs.
• Ongoing technological progress will lead to sustained economic growth.
• Various theories try to explain the origins of technological progress and determine how we can promote it. They include spending on research and development, creative destruction, the scale of the market, induced inventions, and education and the accumulation of knowledge, including investments in human capital.
• Governments can play a key role in designing institutions that promote economic growth, including providing secure property rights.
Learning Objectives
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Calculate economic growth rates.
Explain the role of capital in economic growth.
Apply growth accounting to measure technological progress.
Discuss the sources of technological progress.
Assess the role of government in assisting economic growth.
8.1 Economic Growth Rates
In Chapter 5, economic growth was defined as sustained increases in the real GDP of an economy over a long period of time. Economic growth can be illustrated with the use of the production possibilities curve, as shown in Figure 8.1.
Because real GDP is the indicator of economic growth, real GDP is a starting point for measuring such growth. A country’s economic growth can be measured from one year to the next using real GDP. If we want to measure how real GDP affects the population, then we need a different measurement. The measurement we use for this purpose is called real GDP per capita. Real GDP per capita is gross domestic product per person adjusted for changes in prices. It is the usual measure of living standards across time and between countries.
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If we compare people in the United States who lived in the 18th century to people today, we can see they have different economic conditions. For example, people in the 1700s used the fireplace as a place for cooking meals and keeping warm. People today use the fireplace for warmth and decoration. As income increases, standards of living tend to improve. The more income you have in a country, the more its people can afford. A reason to measure economic growth and understand how to make economic growth happen is to improve standards of living. Comparing countries allows economists and policymakers to decide what policy would improve standards of living.
Another way to measure economic growth over time is to use growth rates. A growth rate is the percentage rate of change of a variable from one period to another. You already used growth rates when you calculated inflation rates. This time you will use real GDP as your measure of growth.
If you wish to know how long it takes for a country to double its real GDP, you can use the rule of 70.
The rule of 70 is a rule of thumb that says output will double in 70/x years, where x is the percentage rate of growth. The following are the formulas useful for understanding economic growth:
Study Tip
The best way to get better at calculations is to practice them. Take a moment to practice using the equations below on a few problems at the end of the chapter or on myeconlab.com.
; Key Equations
Real GDP
Population
Real GDPcy - Real GDPpy where “cy” is the current year and
