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.