Chapter 9: Long-Run Economic Growth

📈 Economic Growth Basics

  • Economic Growth: Increase in Real GDP or Real GDP per capita.

  • Real GDP per capita: Measures the average economic output per person, adjusted for inflation.

  • Growth matters because it improves living standards over time.

⚙ Core Driver: Productivity

  • Productivity = Output per worker.

  • Long-run growth depends primarily on productivity, influenced by:

    1. Physical Capital (tools, buildings, machines)

    2. Human Capital (education, skills)

    3. Technology (innovative production methods)

Example: McDonald’s burger process = technological progress.

📊 Aggregate Production Function

  • Shows how productivity depends on:

    • Physical capital per worker

    • Human capital per worker

    • Technology

  • Example formula:
    GDP per worker = T × (physical capital)^0.4 × (human capital)^0.6

📉 Diminishing Returns to Capital

  • Adding more physical capital yields smaller increases in productivity.
    A second computer helps, but not as much as the first.

  • Less-developed countries tend to grow faster (they’re still “catching up”).

🔁 Convergence Hypothesis

  • Poorer countries grow faster than richer ones and catch up over time.

    • Growth rates:

      • High-income: ~1.6%

      • Middle-income: ~3.6%

      • Low-income: ~4%

  • Catch-up effects:

    • Law of diminishing returns

    • Easier adoption of existing technologies

    • “Rapid mover” advantage

🏛 Factors That Influence Economic Growth

Positive Contributors

  • Savings and Investment Spending

  • Education → Human capital

  • Research & Development (R&D)

  • Government Policies:

    1. Infrastructure spending (roads, internet)

    2. Education subsidies

    3. R&D subsidies

    4. Well-functioning financial system

    5. Property rights protection

    6. Political stability & governance

Barriers to Growth

  • Argentina & Latin America: Inflation, poor education, unstable politics

  • Italy: Business culture favors seniority over productivity

  • Africa: Corruption, civil war, geography

🌍 Natural Resources & Sustainability

  • Natural resources are less important today than human/physical capital.

  • Key Questions for long-term growth:

    1. Are resources sufficient?

    2. Can we find alternatives?

    3. Can growth continue sustainably?

Growth ≠ always eco-friendly → Pollution & climate issues (e.g., Paris Agreement 2015)

💸 Financial Sector’s Role

  • Connects savers with borrowers

  • Two parts:

    • Markets (stocks, bonds)

    • Institutions (banks, credit unions)

  • Enables investment → needed for productivity growth

📉 Recent Economic Policy Notes (March 2025)

🏦 Federal Reserve Update

  • Fed held interest rates steady (no change to federal funds rate).

  • Waiting due to uncertainty (e.g., tariffs) and fear of stagflation (recession + inflation).

  • Jerome Powell speech caused stock markets to rise (Dow +400).

📉 Interest Rates and Behavior

  • Lower rates → cheaper mortgages, credit cards, etc.

  • But falling demand for loans → signals economic anxiety → can lead to downturn.

  • Fed likely to lower rates twice in 2025.

🧠 Final Key Ideas

  • Rule of 70:
    Doubling time = 70 ÷ growth rate
    e.g., 3.5% growth rate → GDP doubles in 20 years.

  • Even small growth rates compound → major long-term impact.

  • Economic growth affects lifestyle, resources, and future generations.