Macro Chapter 8-10 Real GDP and the Price Level in the Short Run
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About This Presentation
Chapter 8 - 10
Slide Content
Copyright © 2023 Pearson Canada Inc. 8 -1
9.1 Three Macroeconomic States
•The Short Run
–The assumptions of the model in the short run are:
Factor prices are assumed to be exogenous; they may
change, but any change is not explained within the
model.
Technology and factor supplies are assumed to be
constant (and therefore Y*is constant).
9.1 Three Macroeconomic States
•The Short Run
–The assumptions of the model in the short run are:
Factor prices are assumed to be exogenous; they may
change, but any change is not explained within the
model.
Technology and factor supplies are assumed to be
constant (and therefore Y*is constant).
Copyright © 2023 Pearson Canada Inc. 8 -2
The Adjustment of Factor Prices
•The assumptions of the theory of the adjustment
process are:
–Factor prices are assumed to adjust in response to
output gaps.
–Technology and factor supplies are assumed to be
constant (and therefore Y*is constant).
The Adjustment of Factor Prices
•The assumptions of the theory of the adjustment
process are:
–Factor prices are assumed to adjust in response to
output gaps.
–Technology and factor supplies are assumed to be
constant (and therefore Y*is constant).
Copyright © 2023 Pearson Canada Inc. 8 -3
The Long Run
•The assumptions of the model in the long run are:
–Factor prices are assumed to have fully adjusted to any
output gap.
–Technology and factor supplies are assumed to be
changing.
The Long Run
•The assumptions of the model in the long run are:
–Factor prices are assumed to have fully adjusted to any
output gap.
–Technology and factor supplies are assumed to be
changing.
Copyright © 2023 Pearson Canada Inc. 8 -4
Table 9-1 Three Macroeconomic States
Blank
The Short Run The Adjustment Process The Long Run
Key Assumptions Factor prices are
exogenous.
Factor prices are
flexible/endogenous.
Factor prices are fully
adjusted/endogenous.
Technology and factor
supplies (and thus Y*) are
constant/exogenous.
Technology and factor
supplies (and thus Y*) are
constant/exogenous.
Technology and factor
supplies (and thus Y*)
are changing.
What Happens Real GDP (Y) is determined
by aggregate demand and
aggregate supply.
Factor prices adjust to output
gaps; real GDP eventually
returns to Y*.
Potential GDP (Y*)
grows over the long run.
Why We Study This
State
To show the effects of AD
and AS shocks on real
GDP.
To see how output gaps cause
factor prices to change and
why real GDP tends to return
to Y*.
To understand the
nature of long- run
economic growth.
Table 9-1 Three Macroeconomic States
Blank
The Short Run The Adjustment Process The Long Run
Key Assumptions Factor prices are
exogenous.
Factor prices are
flexible/endogenous.
Factor prices are fully
adjusted/endogenous.
Technology and factor
supplies (and thus Y*) are
constant/exogenous.
Technology and factor
supplies (and thus Y*) are
constant/exogenous.
Technology and factor
supplies (and thus Y*)
are changing.
What Happens Real GDP (Y) is determined
by aggregate demand and
aggregate supply.
Factor prices adjust to output
gaps; real GDP eventually
returns to Y*.
Potential GDP (Y*)
grows over the long run.
Why We Study This
State
To show the effects of AD
and AS shocks on real
GDP.
To see how output gaps cause
factor prices to change and
why real GDP tends to return
to Y*.
To understand the
nature of long- run
economic growth.
Copyright © 2023 Pearson Canada Inc. 8 -58 -5
Ragan: Macroeconomics
Seventeenth Canadian Edition
Chapter 8
Real GDP and the Price Level
in the Short Run
Copyright © 2023 Pearson Canada Inc.
Ragan: Macroeconomics
Seventeenth Canadian Edition
Chapter 8
Real GDP and the Price Level
in the Short Run
Copyright © 2023 Pearson Canada Inc.
Copyright © 2023 Pearson Canada Inc. 8 -6
8.1 The Demand Side of the Economy
•Exogenous Changes in the Price Level
–Changes in Consumption
Much of the private sector’s total wealth is held in the
form of assets with a fixed nominal value.
The most obvious example is money.
What this money can buy—its real value—depends on
the price level.
A rise in the price level lowers the real value of money
held by the private sector, and a fall in the price level
raises the real value of money held by the private sector.
8.1 The Demand Side of the Economy
•Exogenous Changes in the Price Level
–Changes in Consumption
Much of the private sector’s total wealth is held in the
form of assets with a fixed nominal value.
The most obvious example is money.
What this money can buy—its real value—depends on
the price level.
A rise in the price level lowers the real value of money
held by the private sector, and a fall in the price level
raises the real value of money held by the private sector.
Copyright © 2023 Pearson Canada Inc. 8 -7
Changes in Consumption
•Changes in the price level change the wealth of
bondholders and bond issuers, but because the changes
offset each other, there is no change in aggregate wealth.
•In summary, a rise in the price level leads to a reduction
in the real value of the private sector’s wealth.
•A reduction in wealth leads to a decrease in autonomous
desired consumption and to a downward shift in the AE
function.
•A fall in the price level leads to a rise in wealth and desired
consumption and to an upward shift in the AEfunction.
Changes in Consumption
•Changes in the price level change the wealth of
bondholders and bond issuers, but because the changes
offset each other, there is no change in aggregate wealth.
•In summary, a rise in the price level leads to a reduction
in the real value of the private sector’s wealth.
•A reduction in wealth leads to a decrease in autonomous
desired consumption and to a downward shift in the AE
function.
•A fall in the price level leads to a rise in wealth and desired
consumption and to an upward shift in the AEfunction.
Copyright © 2023 Pearson Canada Inc. 8 -8
Changes in Net Exports (1 of 2)
•When the domestic price level rises (and the
exchange rate remains unchanged), Canadian goods
become more expensive relative to foreign goods.
•Canadian consumers reduce their purchases of
Canadian-made goods and increase their purchases
of foreign goods.
•Consumers in other countries reduce their purchases
of Canadian-made goods.
Changes in Net Exports (1 of 2)
•When the domestic price level rises (and the
exchange rate remains unchanged), Canadian goods
become more expensive relative to foreign goods.
•Canadian consumers reduce their purchases of
Canadian-made goods and increase their purchases
of foreign goods.
•Consumers in other countries reduce their purchases
of Canadian-made goods.
Copyright © 2023 Pearson Canada Inc. 8 -9
Changes in Net Exports (2 of 2)
•A rise in the domestic price level (with a constant
exchange rate) shifts the net export function
downward, which causes a downward shift in the AE
curve.
•A fall in the domestic price level shifts the net export
function upward and the AEcurve upward.
Changes in Net Exports (2 of 2)
•A rise in the domestic price level (with a constant
exchange rate) shifts the net export function
downward, which causes a downward shift in the AE
curve.
•A fall in the domestic price level shifts the net export
function upward and the AEcurve upward.
Copyright © 2023 Pearson Canada Inc. 8 -10
Changes in Equilibrium GDP
•An exogenous increase
in the price level causes
AE
0to shift downward
from to AE
1.
•The equilibrium
changes from E
0to E
1
and real GDP falls from
Y
0to Y
1.
Figure 8- 1Desired Aggregate Expenditure and the Price Level
Changes in Equilibrium GDP
•An exogenous increase
in the price level causes
AE
0to shift downward
from to AE
1.
•The equilibrium
changes from E
0to E
1
and real GDP falls from
Y
0to Y
1.
Figure 8- 1Desired Aggregate Expenditure and the Price Level
Copyright © 2023 Pearson Canada Inc. 8 -11
The Aggregate Demand Curve
•The aggregate demand (AD) curve is a curve showing
combinations of real GDP and the price level that make
desired aggregate expenditure equal to actual national
income.
•A rise in the price level causes the AEcurve to shift
downward and leads to a movement upward and to the left
along the ADcurve, reflecting a fall in the equilibrium level
of GDP.
•A fall in the price level causes the AE curve to shift upward
and leads to a movement downward and to the right along
the ADcurve, reflecting a rise in the equilibrium level of
GDP.
The Aggregate Demand Curve
•The aggregate demand (AD) curve is a curve showing
combinations of real GDP and the price level that make
desired aggregate expenditure equal to actual national
income.
•A rise in the price level causes the AEcurve to shift
downward and leads to a movement upward and to the left
along the ADcurve, reflecting a fall in the equilibrium level
of GDP.
•A fall in the price level causes the AE curve to shift upward
and leads to a movement downward and to the right along
the ADcurve, reflecting a rise in the equilibrium level of
GDP.
Copyright © 2023 Pearson Canada Inc. 8 -12
Figure 8-2 Derivation of the AD Curve
•As the price level rises from
P
0to P
1to P
2, the AEcurve
shifts downward from AE
0to
AE
1to AE
2.
•In the bottom graph, a
movement occurs up along
the AD curve.
•A change in the price level
causes a shift of the AE curve
but a movement along the AD
curve.
Figure 8-2 Derivation of the AD Curve
•As the price level rises from
P
0to P
1to P
2, the AEcurve
shifts downward from AE
0to
AE
1to AE
2.
•In the bottom graph, a
movement occurs up along
the AD curve.
•A change in the price level
causes a shift of the AE curve
but a movement along the AD
curve.
Copyright © 2023 Pearson Canada Inc. 8 -13
Shifts in the AD Curve
•Any change that causes the AEcurve to shift will also
cause the ADcurve to shift.
•Such a shift is called an aggregate demand shock.
•An increase in autonomous aggregate expenditure shifts
the AE curve upward and the ADcurve to the right.
•A fall in autonomous aggregate expenditure shifts the
AEcurve downward and the ADcurve to the left.
•The simple multiplier measures the horizontal shift in the
ADcurve in response to a change in autonomous
desired expenditure.
Shifts in the AD Curve
•Any change that causes the AEcurve to shift will also
cause the ADcurve to shift.
•Such a shift is called an aggregate demand shock.
•An increase in autonomous aggregate expenditure shifts
the AE curve upward and the ADcurve to the right.
•A fall in autonomous aggregate expenditure shifts the
AEcurve downward and the ADcurve to the left.
•The simple multiplier measures the horizontal shift in the
ADcurve in response to a change in autonomous
desired expenditure.
Copyright © 2023 Pearson Canada Inc. 8 -14
Figure 8-3 The Simple Multiplier and Shifts in the
ADCurve
•An increase in
autonomous
expenditure shifts AE
0
to AE
1.
•The size of the
horizontal shift of the
AD curve is equal to the
simple multiplier times
the increase in
autonomous
expenditure.
Figure 8-3 The Simple Multiplier and Shifts in the
ADCurve
•An increase in
autonomous
expenditure shifts AE
0
to AE
1.
•The size of the
horizontal shift of the
AD curve is equal to the
simple multiplier times
the increase in
autonomous
expenditure.
Copyright © 2023 Pearson Canada Inc. 8 -15
8.2 The Supply Side of the Economy
•The Aggregate Supply Curve
•The aggregate supply (AS) curve is a curve showing
the relation between the price level and the quantity of
aggregate output supplied, for given technology and
factor prices.
•As output increases, less efficient standby plants may
have to be used, and less efficient workers may have to
be hired, while existing workers may have to be paid
overtime rates for additional work.
•For these reasons, unit cost, which is cost per unit of
output, increases.
8.2 The Supply Side of the Economy
•The Aggregate Supply Curve
•The aggregate supply (AS) curve is a curve showing
the relation between the price level and the quantity of
aggregate output supplied, for given technology and
factor prices.
•As output increases, less efficient standby plants may
have to be used, and less efficient workers may have to
be hired, while existing workers may have to be paid
overtime rates for additional work.
•For these reasons, unit cost, which is cost per unit of
output, increases.
Copyright © 2023 Pearson Canada Inc. 8 -16
Figure 8-4 The Aggregate Supply Curve
•The AScurve is
positively sloped.
•The higher is the level
of output, the faster unit
costs tend to rise, so
the AS curve becomes
steeper as output rises.
Figure 8-4 The Aggregate Supply Curve
•The AScurve is
positively sloped.
•The higher is the level
of output, the faster unit
costs tend to rise, so
the AS curve becomes
steeper as output rises.
Copyright © 2023 Pearson Canada Inc. 8 -17
Shifts in the AS Curve
•Shifts in the AScurve caused by exogenous forces
are called aggregate supply shocks.
•A rise in factor prices causes the AScurve to shift
leftward.
•A fall in factor prices causes the AScurve to shift
rightward.
•An improvement in technology causes the AScurve to
shift rightward.
•A deterioration in technology causes the AScurve to
shift leftward.
Shifts in the AS Curve
•Shifts in the AScurve caused by exogenous forces
are called aggregate supply shocks.
•A rise in factor prices causes the AScurve to shift
leftward.
•A fall in factor prices causes the AScurve to shift
rightward.
•An improvement in technology causes the AScurve to
shift rightward.
•A deterioration in technology causes the AScurve to
shift leftward.
Copyright © 2023 Pearson Canada Inc. 8 -18
Figure 8-5 Shifts in the ASCurve
•An increase in factor
prices or a
deterioration in
technology shifts the
AScurve leftward
from AS
0to AS
1.
Figure 8-5 Shifts in the ASCurve
•An increase in factor
prices or a
deterioration in
technology shifts the
AScurve leftward
from AS
0to AS
1.
Copyright © 2023 Pearson Canada Inc. 8 -19
8.3 Macroeconomic Equilibrium
•Demand behaviour
is consistent with
supply behaviour
only at the
intersection of the
ASand ADcurves.
•E
0is the
macroeconomic
equilibrium.
Figure 8- 6Macroeconomic Equilibrium
8.3 Macroeconomic Equilibrium
•Demand behaviour
is consistent with
supply behaviour
only at the
intersection of the
ASand ADcurves.
•E
0is the
macroeconomic
equilibrium.
Figure 8- 6Macroeconomic Equilibrium
Copyright © 2023 Pearson Canada Inc. 8 -20
Changes in Macroeconomic Equilibrium
•A shift in the ADcurve is called an aggregate demand
shock.
•A shift in the AScurve is called an aggregate supply
shock.
•Aggregate demand and aggregate supply shocks are
labelled according to their effect on real GDP.
•Positive shocks increase equilibrium GDP; negative
shocks reduce equilibrium GDP.
Changes in Macroeconomic Equilibrium
•A shift in the ADcurve is called an aggregate demand
shock.
•A shift in the AScurve is called an aggregate supply
shock.
•Aggregate demand and aggregate supply shocks are
labelled according to their effect on real GDP.
•Positive shocks increase equilibrium GDP; negative
shocks reduce equilibrium GDP.
Copyright © 2023 Pearson Canada Inc. 8 -21
Figure 8-7 Aggregate Demand Shocks
•Aggregate demand
shocks cause the price
level and real GDP to
change in the same
direction.
•Both rise with an
increase in aggregate
demand, and both fall
with a decrease in
aggregate demand.
Figure 8-7 Aggregate Demand Shocks
•Aggregate demand
shocks cause the price
level and real GDP to
change in the same
direction.
•Both rise with an
increase in aggregate
demand, and both fall
with a decrease in
aggregate demand.
Copyright © 2023 Pearson Canada Inc. 8 -22
Figure 8-8 The Multiplier When the Price Level
Varies
•An increase in
autonomous
expenditure causes
the AE curve to shift
upward, but the rise
in the price level
causes it to shift part
of the way down
again.
Figure 8-8 The Multiplier When the Price Level
Varies
•An increase in
autonomous
expenditure causes
the AE curve to shift
upward, but the rise
in the price level
causes it to shift part
of the way down
again.
Copyright © 2023 Pearson Canada Inc. 8 -23
Figure 8-9 The Effects of Increases in Aggregate
Demand
•The effect of any given
shift in AD will be
divided between a
change in Yand a
change in P.
•The steeper the AS
curve, the greater the
price effect and the
smaller the output
effect.
Figure 8-9 The Effects of Increases in Aggregate
Demand
•The effect of any given
shift in AD will be
divided between a
change in Yand a
change in P.
•The steeper the AS
curve, the greater the
price effect and the
smaller the output
effect.
Copyright © 2023 Pearson Canada Inc. 8 -24
Figure 8-10 Aggregate Supply Shocks
•ASshocks cause P and Y to
change in opposite
directions.
•A negative supply shock
shifts the AS curve leftward,
and the rise in the price level
shifts the AE curve
downward.
Figure 8-10 Aggregate Supply Shocks
•ASshocks cause P and Y to
change in opposite
directions.
•A negative supply shock
shifts the AS curve leftward,
and the rise in the price level
shifts the AE curve
downward.
Copyright © 2023 Pearson Canada Inc. 8 -25
Analyzing the 2020 Pandemic
Recession with the AD/ASModel
(1 of 2)
•The combined effect of the negative AS shock and the
negative ADshock from the COVID-19 pandemic was
a sharp reduction in output and employment.
•The economy’s ability to combine land, labour and
capital to produce output was severely reduced. There
was a large leftward shift in the AScurve, and real
GDP declined.
•For both businesses and households, the pandemic
led to a significant reduction in demand even for an
unchanged level of income. There was a large
leftward shift of the ADcurve, and real GDP fell.
Analyzing the 2020 Pandemic
Recession with the AD/ASModel
(1 of 2)
•The combined effect of the negative AS shock and the
negative ADshock from the COVID-19 pandemic was
a sharp reduction in output and employment.
•The economy’s ability to combine land, labour and
capital to produce output was severely reduced. There
was a large leftward shift in the AScurve, and real
GDP declined.
•For both businesses and households, the pandemic
led to a significant reduction in demand even for an
unchanged level of income. There was a large
leftward shift of the ADcurve, and real GDP fell.
Copyright © 2023 Pearson Canada Inc. 8 -26
Analyzing the 2020 Pandemic
Recession with the AD/AS Model
(2 of 2)
•By the middle of 2021, vaccines for COVID-19 were
becoming available in many countries and most
economies were beginning to recover.
•Once individuals are able to safely return to their
workplaces, the ASshock will reverse relatively
quickly.
•Once stores, restaurants, airlines, and hotels are able
to safely conduct business, households and firms will
return to their normal level of demand. The AD shock
will reverse relatively quickly.
Analyzing the 2020 Pandemic
Recession with the AD/AS Model
(2 of 2)
•By the middle of 2021, vaccines for COVID-19 were
becoming available in many countries and most
economies were beginning to recover.
•Once individuals are able to safely return to their
workplaces, the ASshock will reverse relatively
quickly.
•Once stores, restaurants, airlines, and hotels are able
to safely conduct business, households and firms will
return to their normal level of demand. The AD shock
will reverse relatively quickly.
Copyright © 2023 Pearson Canada Inc. 8 -27
A Word of Warning
•Many economic events ‒ especially changes in the
world price of raw materials ‒ cause both aggregate
demand and aggregate supply shocks in the same
economy.
•The overall effect on real GDP in that economy
depends on the relative importance of the demand-
side and supply-side effects.
A Word of Warning
•Many economic events ‒ especially changes in the
world price of raw materials ‒ cause both aggregate
demand and aggregate supply shocks in the same
economy.
•The overall effect on real GDP in that economy
depends on the relative importance of the demand-
side and supply-side effects.
Copyright © 2023 Pearson Canada Inc. 8 -288 -28
Ragan: Macroeconomics
Seventeenth Canadian Edition
Chapter 9
From the Short Run to the
Long Run: The Adjustment of
Factor Prices
Copyright © 2023 Pearson Canada Inc.
Ragan: Macroeconomics
Seventeenth Canadian Edition
Chapter 9
From the Short Run to the
Long Run: The Adjustment of
Factor Prices
Copyright © 2023 Pearson Canada Inc.
Copyright © 2023 Pearson Canada Inc. 8 -29
9.2 The Adjustment Process
•Potential Output and the Output Gap
Figure 9- 1Output Gaps in the Short Run
9.2 The Adjustment Process
•Potential Output and the Output Gap
Figure 9- 1Output Gaps in the Short Run
Copyright © 2023 Pearson Canada Inc. 8 -30
Factor Prices and the Output Gap
•Output Above Potential, Y> Y*
–Because firms are producing beyond their normal
capacity output, there is an excess demand for all
factor inputs.
–Workers will find that they have considerable
bargaining power, and they will put upward pressure on
wages.
–The boom that is associated with an inflationary gap
generates conditions ‒ high profits for firms and an
excess demand for labour‒ that tends to cause wages
to rise.
Factor Prices and the Output Gap
•Output Above Potential, Y> Y*
–Because firms are producing beyond their normal
capacity output, there is an excess demand for all
factor inputs.
–Workers will find that they have considerable
bargaining power, and they will put upward pressure on
wages.
–The boom that is associated with an inflationary gap
generates conditions ‒ high profits for firms and an
excess demand for labour‒ that tends to cause wages
to rise.
Copyright © 2023 Pearson Canada Inc. 8 -31
Output Below Potential, Y < Y*
•Because firms are producing below their normal
capacity output, there is an excess supply of all factor
inputs, including labour.
•Firms will have below-normal sales and not only will
resist upward pressures on wages but also may seek
reductions in wages.
•The slump that is associated with a recessionary gap
generates conditions ‒ low profits for firms and an
excess supply of labour‒ that tends to cause wages
to fall.
Output Below Potential, Y < Y*
•Because firms are producing below their normal
capacity output, there is an excess supply of all factor
inputs, including labour.
•Firms will have below-normal sales and not only will
resist upward pressures on wages but also may seek
reductions in wages.
•The slump that is associated with a recessionary gap
generates conditions ‒ low profits for firms and an
excess supply of labour‒ that tends to cause wages
to fall.
Copyright © 2023 Pearson Canada Inc. 8 -32
Downward Wage Stickiness
•Both upward and downward adjustments to wages
and unit costs do occur, but there are differences in
the speed at which they typically operate.
•Booms can cause wages to rise rapidly.
•Recessions usually cause wages to fall only slowly.
Downward Wage Stickiness
•Both upward and downward adjustments to wages
and unit costs do occur, but there are differences in
the speed at which they typically operate.
•Booms can cause wages to rise rapidly.
•Recessions usually cause wages to fall only slowly.
Copyright © 2023 Pearson Canada Inc. 8 -33
The Phillips Curve
•A.W. Philips observed that wages tended to fall in
periods of high unemploymentand rise in periods
of low unemployment.
•The resulting negative relationship between
unemployment and the rate of change in wages
has been called the Phillips curve ever since.
The Phillips Curve
•A.W. Philips observed that wages tended to fall in
periods of high unemploymentand rise in periods
of low unemployment.
•The resulting negative relationship between
unemployment and the rate of change in wages
has been called the Phillips curve ever since.
Copyright © 2023 Pearson Canada Inc. 8 -34
Potential Output as an “Anchor”
•Following an ADor ASshock, the
short- run equilibrium level of output
may be different from potential
output.
•Any output gap is assumed to cause
wages and other factor prices to
adjust, eventually bringing the
equilibrium level of output back to
potential.
•The level of potential output therefore
acts like an “anchor” for the economy.
Potential Output as an “Anchor”
•Following an ADor ASshock, the
short- run equilibrium level of output
may be different from potential
output.
•Any output gap is assumed to cause
wages and other factor prices to
adjust, eventually bringing the
equilibrium level of output back to
potential.
•The level of potential output therefore
acts like an “anchor” for the economy.
Copyright © 2023 Pearson Canada Inc. 8 -35
9.3 Aggregate Demand and Supply
Shocks
•Positive ADShocks
Figure 9- 2The Adjustment Process Following a Positive AD Shock
9.3 Aggregate Demand and Supply
Shocks
•Positive ADShocks
Figure 9- 2The Adjustment Process Following a Positive AD Shock
Copyright © 2023 Pearson Canada Inc. 8 -36Copyright © 2023 Pearson Canada Inc. 8 -36
Negative ADShocks
Figure 9- 3The Adjustment Process Following a Negative AD Shock
Negative ADShocks
Figure 9- 3The Adjustment Process Following a Negative AD Shock
Copyright © 2023 Pearson Canada Inc. 8 -37Copyright © 2023 Pearson Canada Inc. 8 -37
Aggregate Supply Shocks
Figure 9- 4 The Adjustment Process Following a Negative AS Shock
Aggregate Supply Shocks
Figure 9- 4 The Adjustment Process Following a Negative AS Shock
Copyright © 2023 Pearson Canada Inc. 8 -38
Long-Run Equilibrium
•Following any ADor ASshocks, the adjustment of
factor prices continues until real GDP returns to Y*.
•The economy is in long-run equilibriumwhen this
adjustment process is complete and there is no longer
an output gap.
•So the economy is in long-run equilibrium when the
intersection of the ADand AScurves occurs
at Y*.
Long-Run Equilibrium
•Following any ADor ASshocks, the adjustment of
factor prices continues until real GDP returns to Y*.
•The economy is in long-run equilibriumwhen this
adjustment process is complete and there is no longer
an output gap.
•So the economy is in long-run equilibrium when the
intersection of the ADand AScurves occurs
at Y*.
Copyright © 2023 Pearson Canada Inc. 8 -39
Figure 9-5 Changes in Long- Run Equilibrium
•In part (i), a shift in the AD
curve raises the price level
but leaves real GDP
unchanged in the long run.
•In part (ii), an increase in
potential output raises real
GDP and lowers the price
level.
Figure 9-5 Changes in Long- Run Equilibrium
•In part (i), a shift in the AD
curve raises the price level
but leaves real GDP
unchanged in the long run.
•In part (ii), an increase in
potential output raises real
GDP and lowers the price
level.
Copyright © 2023 Pearson Canada Inc. 8 -40
The Canadian Wage-Adjustment
Process: Empirical Evidence
•Canadian data confirm
that positive output gaps
tend to drive wages and
costs upward.
•Negative output gaps
tend to drive wages and
costs downward.
Figure 9- 6The Canadian Phillips Curve, 1991– 2018
(Source: Author’s calculations using data from the Bank of
Canada and Statistics Canada.)
The Canadian Wage-Adjustment
Process: Empirical Evidence
•Canadian data confirm
that positive output gaps
tend to drive wages and
costs upward.
•Negative output gaps
tend to drive wages and
costs downward.
Figure 9- 6The Canadian Phillips Curve, 1991– 2018
(Source: Author’s calculations using data from the Bank of
Canada and Statistics Canada.)
Copyright © 2023 Pearson Canada Inc. 8 -41
9.4 Fiscal Stabilization Policy
•The government may use various fiscal tools to try to
push real GDP back towards potential output.
•The alternatives to using fiscal stabilization policy are
to wait for the recovery of private-sector demand (a
shift in the ADcurve) or to wait for the economy’s
adjustmentprocess (a shift in the AScurve).
•Examples of fiscal effects: WWII/Recession 2008
9.4 Fiscal Stabilization Policy
•The government may use various fiscal tools to try to
push real GDP back towards potential output.
•The alternatives to using fiscal stabilization policy are
to wait for the recovery of private-sector demand (a
shift in the ADcurve) or to wait for the economy’s
adjustmentprocess (a shift in the AScurve).
•Examples of fiscal effects: WWII/Recession 2008
Copyright © 2023 Pearson Canada Inc. 8 -42Copyright © 2023 Pearson Canada Inc. 8 -42
The Basic Theory of Fiscal Stabilization
(1 of 2)
•The effect of any given shift in ADwill be divided between
a change in Yand a change in P.
•The steeper the AS curve, the greater the price effect and
the smaller the output effect.
Figure 9- 7The Closing of a Recessionary Gap
The Basic Theory of Fiscal Stabilization
(1 of 2)
•The effect of any given shift in ADwill be divided between
a change in Yand a change in P.
•The steeper the AS curve, the greater the price effect and
the smaller the output effect.
Figure 9- 7The Closing of a Recessionary Gap
Copyright © 2023 Pearson Canada Inc. 8 -43Copyright © 2023 Pearson Canada Inc. 8 -43
The Basic Theory of Fiscal Stabilization
(2 of 2)
•AS shocks cause P and Y to change in opposite
directions.
•A negative supply shock shifts the AScurve leftward, and
the rise in the price level shifts the AE curve downward.
Figure 9- 8The Closing of an Inflationary Gap
The Basic Theory of Fiscal Stabilization
(2 of 2)
•AS shocks cause P and Y to change in opposite
directions.
•A negative supply shock shifts the AScurve leftward, and
the rise in the price level shifts the AE curve downward.
Figure 9- 8The Closing of an Inflationary Gap
Copyright © 2023 Pearson Canada Inc. 8 -44
Short Run Versus Long Run
•The paradox of thrift—the idea that an increase in
saving reduces the level of real GDP—is true only in
the short run.
•In the long run, the path of real GDP is determined by
the path of potential output.
•The increase in saving has the long-run effect of
increasing investment and therefore increasing
potential output.
Short Run Versus Long Run
•The paradox of thrift—the idea that an increase in
saving reduces the level of real GDP—is true only in
the short run.
•In the long run, the path of real GDP is determined by
the path of potential output.
•The increase in saving has the long-run effect of
increasing investment and therefore increasing
potential output.
Copyright © 2023 Pearson Canada Inc. 8 -45
Automatic Fiscal Stabilizers (1 of 2)
•Suppose a shock shifts ADright and increases short- run
real GDP.
•As real GDP increases, government tax revenues also
increase.
•With fewer low- income households and unemployed
persons requiring assistance, governments transfers fall.
•The rise in net tax revenues dampens the overall increase
in real GDP caused by the initial shock.
•The tax-and-transfer system reduces the value of the
multiplier and acts as an automatic stabilizer for the
economy.
Automatic Fiscal Stabilizers (1 of 2)
•Suppose a shock shifts ADright and increases short- run
real GDP.
•As real GDP increases, government tax revenues also
increase.
•With fewer low- income households and unemployed
persons requiring assistance, governments transfers fall.
•The rise in net tax revenues dampens the overall increase
in real GDP caused by the initial shock.
•The tax-and-transfer system reduces the value of the
multiplier and acts as an automatic stabilizer for the
economy.
Copyright © 2023 Pearson Canada Inc. 8 -46
Automatic Fiscal Stabilizers (2 of 2)
•The marginal propensity to spend on national income is:
z= MPC(1 –t) –m
•The simple multiplier is:
Simple multiplier = 1/ (1 –z)
•The lower the net tax rate (t), the larger the simple
multiplier and thus the less stable is real GDP in
response to shocks to autonomous spending.
Automatic Fiscal Stabilizers (2 of 2)
•The marginal propensity to spend on national income is:
z= MPC(1 –t) –m
•The simple multiplier is:
Simple multiplier = 1/ (1 –z)
•The lower the net tax rate (t), the larger the simple
multiplier and thus the less stable is real GDP in
response to shocks to autonomous spending.
Copyright © 2023 Pearson Canada Inc. 8 -47
Limitations of Discretionary Fiscal
Policy
•Decision and Execution Lags
•Temporary versus Permanent Tax Changes
•Fine Tuning versus Gross Tuning
Limitations of Discretionary Fiscal
Policy
•Decision and Execution Lags
•Temporary versus Permanent Tax Changes
•Fine Tuning versus Gross Tuning
Copyright © 2023 Pearson Canada Inc. 8 -48
Fiscal Policy and Growth
•If an increase in government purchasesleads to an
increase in potential output (or its growth rate), the
negative effects from the crowding out of private
investment will be reduced.
•Reductions in tax ratesgenerate a short-run
demand stimulus and may also generate a longer-run
increase in the level and growth rate of potential
output.
Fiscal Policy and Growth
•If an increase in government purchasesleads to an
increase in potential output (or its growth rate), the
negative effects from the crowding out of private
investment will be reduced.
•Reductions in tax ratesgenerate a short-run
demand stimulus and may also generate a longer-run
increase in the level and growth rate of potential
output.
Copyright © 2023 Pearson Canada Inc. 8 -498 -49
Ragan: Macroeconomics
Seventeenth Canadian Edition
Chapter 10
Long- Run Economic Growth
Copyright © 2023 Pearson Canada Inc.
Ragan: Macroeconomics
Seventeenth Canadian Edition
Chapter 10
Long- Run Economic Growth
Copyright © 2023 Pearson Canada Inc.
Copyright © 2023 Pearson Canada Inc. 8 -50
Chapter Outline/Learning Objectives
Section Learning Objectives
Blank After studying this chapter, you will be able to
10.1 The Nature of Economic
Growth
1.discuss the costs and benefits of
economic growth.
2.list four important determinants of growth
in potential GDP.
10.2Economic Growth: Basic
Relationships
3.describe the relationship between
investment, saving, and long-run growth.
4.explain the main elements of Neoclassical
growth theory in which technological
change is exogenous.
10.3Economic Growth: Advanced
Theories
5.discuss advanced growth theories based
on endogenous technical change and
increasing returns.
10.4Are There Limits to Growth? 6.explain why resource exhaustion and
environmental degradation may create
serious challenges for public policy
directed at sustaining economic growth.
Chapter Outline/Learning Objectives
Section Learning Objectives
Blank After studying this chapter, you will be able to
10.1 The Nature of Economic
Growth
1.discuss the costs and benefits of
economic growth.
2.list four important determinants of growth
in potential GDP.
10.2Economic Growth: Basic
Relationships
3.describe the relationship between
investment, saving, and long-run growth.
4.explain the main elements of Neoclassical
growth theory in which technological
change is exogenous.
10.3Economic Growth: Advanced
Theories
5.discuss advanced growth theories based
on endogenous technical change and
increasing returns.
10.4Are There Limits to Growth? 6.explain why resource exhaustion and
environmental degradation may create
serious challenges for public policy
directed at sustaining economic growth.
Copyright © 2023 Pearson Canada Inc. 8 -51Copyright © 2023 Pearson Canada Inc. 8 -51
10.1 The Nature of Economic Growth
Figure 10- 1Three Aspects of Economic Growth
10.1 The Nature of Economic Growth
Figure 10- 1Three Aspects of Economic Growth
Copyright © 2023 Pearson Canada Inc. 8 -52
Table 10-1 The Cumulative Effect of
Economic Growth
Annual Growth Rate
Year 1% 2% 3% 5% 7%
0 100 100 100 100 100
10 111 122 134 163 197
30 135 181 243 432 761
50 165 269 438 1 147 2 946
70 201 400 792 3 043 11 399
100 271 725 1 922 13 150 86 772
Small differences in income growth rates make enormous differences in
levels of income over a few decades.Let income be 100 in year 0. At a
growth rate of 3 percent per year, it will be 134 in 10 years, 438 after 50 years,
and 1922 after a century. Notice the difference between 2 percent and 3 percent
growth—even small differences in growth rates make big differences in future
income levels.
Table 10-1 The Cumulative Effect of
Economic Growth
Annual Growth Rate
Year 1% 2% 3% 5% 7%
0 100 100 100 100 100
10 111 122 134 163 197
30 135 181 243 432 761
50 165 269 438 1 147 2 946
70 201 400 792 3 043 11 399
100 271 725 1 922 13 150 86 772
Small differences in income growth rates make enormous differences in
levels of income over a few decades.Let income be 100 in year 0. At a
growth rate of 3 percent per year, it will be 134 in 10 years, 438 after 50 years,
and 1922 after a century. Notice the difference between 2 percent and 3 percent
growth—even small differences in growth rates make big differences in future
income levels.
Copyright © 2023 Pearson Canada Inc. 8 -53
Benefits of Economic Growth
•Rising Average Living Standards
–Economic growth is a powerful means of improving
average materialliving standards.
–Economic growth that raises average income tends to
change the whole society’s consumption patterns,
shifting away from tangible goods toward services.
–Economic growth provides the higher incomes that
often lead to a demand for a cleaner environment.
Benefits of Economic Growth
•Rising Average Living Standards
–Economic growth is a powerful means of improving
average materialliving standards.
–Economic growth that raises average income tends to
change the whole society’s consumption patterns,
shifting away from tangible goods toward services.
–Economic growth provides the higher incomes that
often lead to a demand for a cleaner environment.
Copyright © 2023 Pearson Canada Inc. 8 -54
Addressing Poverty and Income
Inequality
•In recent years, the majority of aggregate income
growth in many countries, including Canada, has been
accruing to the top earnersin the income
distribution.
•While average per capital incomes have been rising,
there has also been a rise in income inequality
•Poverty and income inequality are important
challenges for public policy.
Addressing Poverty and Income
Inequality
•In recent years, the majority of aggregate income
growth in many countries, including Canada, has been
accruing to the top earnersin the income
distribution.
•While average per capital incomes have been rising,
there has also been a rise in income inequality
•Poverty and income inequality are important
challenges for public policy.
Copyright © 2023 Pearson Canada Inc. 8 -55
APPLYING ECONOMIC CONCEPTS (1 of 2)
10-2 A Case Against Economic Growth
–Presents a case against continued economic growth,
especially in the developed countries
–Growth is not sustainable
–Growth may not increase overall well- being
APPLYING ECONOMIC CONCEPTS (1 of 2)
10-2 A Case Against Economic Growth
–Presents a case against continued economic growth,
especially in the developed countries
–Growth is not sustainable
–Growth may not increase overall well- being
Copyright © 2023 Pearson Canada Inc. 8 -56
Costs of Economic Growth
•Forgone Consumption
–Economic growth, which promises more goods and
services in the future, is achieve by consuming fewer
goods today. This sacrifice of current consumption is
an important cost of growth.
•Social Costs
–The process of economic growth is disruptive for some
businesses and workers. There are social costs from
workers’ skills becoming obsolete.
Costs of Economic Growth
•Forgone Consumption
–Economic growth, which promises more goods and
services in the future, is achieve by consuming fewer
goods today. This sacrifice of current consumption is
an important cost of growth.
•Social Costs
–The process of economic growth is disruptive for some
businesses and workers. There are social costs from
workers’ skills becoming obsolete.
Copyright © 2023 Pearson Canada Inc. 8 -57
Sources of Economic Growth
•Four major determinants of growth are:
1.Growth in the labour force
2.Growth in human capital
3.Growth in physical capital
4.Technological improvement
•Different theories or economic growth emphasize
different sources of growth.
Sources of Economic Growth
•Four major determinants of growth are:
1.Growth in the labour force
2.Growth in human capital
3.Growth in physical capital
4.Technological improvement
•Different theories or economic growth emphasize
different sources of growth.
Copyright © 2023 Pearson Canada Inc. 8 -58
10.2 Economic Growth: Basic
Relationships
•A Long-Run Analysis
–In the simplest short-run macro model, the equilibrium
level of real GDP is such that real GDP equals desired
consumption plus desired investment:
Y= C+ I
Y–C= I or S= I
–In the short- run, real GDP adjusts to determine
equilibrium, in which desired saving equals desired
investment.
–In the model’s long- run version, real GDP is equal to Y*
and the interest rate adjusts to determine equilibrium.
10.2 Economic Growth: Basic
Relationships
•A Long-Run Analysis
–In the simplest short-run macro model, the equilibrium
level of real GDP is such that real GDP equals desired
consumption plus desired investment:
Y= C+ I
Y–C= I or S= I
–In the short- run, real GDP adjusts to determine
equilibrium, in which desired saving equals desired
investment.
–In the model’s long- run version, real GDP is equal to Y*
and the interest rate adjusts to determine equilibrium.
Copyright © 2023 Pearson Canada Inc. 8 -59
Investment, Saving, and Growth (1 of 2)
•We now add a government sector that purchases goods
and services (G ) and collects taxes net of transfers (T).
•With real GDP equal to Y* in the long run, desired
private saving is equal to:
Private saving = Y* − T− C
•Public saving is equal to the combined budget surpluses
of the federal, provincial, and municipal governments.
Public saving = T –G
Investment, Saving, and Growth (1 of 2)
•We now add a government sector that purchases goods
and services (G ) and collects taxes net of transfers (T).
•With real GDP equal to Y* in the long run, desired
private saving is equal to:
Private saving = Y* − T− C
•Public saving is equal to the combined budget surpluses
of the federal, provincial, and municipal governments.
Public saving = T –G
Copyright © 2023 Pearson Canada Inc. 8 -60
Investment, Saving, and Growth (2 of 2)
National saving = NS= Y*−T − C+ (T − G)
NS = Y* − C− G
•So for a given level of real GDP in the long run (Y*),
an increase in household consumption or government
purchases implies a reduction in national saving.
•The supply curve for national saving and the
investment demand curve make up the economy’s
market for financial capital.
Investment, Saving, and Growth (2 of 2)
National saving = NS= Y*−T − C+ (T − G)
NS = Y* − C− G
•So for a given level of real GDP in the long run (Y*),
an increase in household consumption or government
purchases implies a reduction in national saving.
•The supply curve for national saving and the
investment demand curve make up the economy’s
market for financial capital.
Copyright © 2023 Pearson Canada Inc. 8 -61Copyright © 2023 Pearson Canada Inc. 8 -61
Figure 10- 2 Investment and Saving in the Long
Run
In the long run, the condition that desired national saving equals desired investment determines the equilibrium
real interest rate.
Figure 10- 2 Investment and Saving in the Long
Run
In the long run, the condition that desired national saving equals desired investment determines the equilibrium
real interest rate.
Copyright © 2023 Pearson Canada Inc. 8 -62
Increases in Investment Demand and
the Supply of National Saving
(1 of 4)
•An increase in the supply of national saving (NS )
reduces the real interest rate and encourages more
investment.
•The higher rate of investment leads to a higher growth
rate of potential output.
Increases in Investment Demand and
the Supply of National Saving
(1 of 4)
•An increase in the supply of national saving (NS )
reduces the real interest rate and encourages more
investment.
•The higher rate of investment leads to a higher growth
rate of potential output.
Copyright © 2023 Pearson Canada Inc. 8 -63Copyright © 2023 Pearson Canada Inc. 8 -63
Figure 10- 3(i) Increases in Investment Demand
and the Supply of National Saving
(2 of 4)
Changes in the supply of national saving or the demand for investment will change the equilibrium real interest
rate and the rate of growth of potential output.
Figure 10- 3(i) Increases in Investment Demand
and the Supply of National Saving
(2 of 4)
Changes in the supply of national saving or the demand for investment will change the equilibrium real interest
rate and the rate of growth of potential output.
Copyright © 2023 Pearson Canada Inc. 8 -64
Increases in Investment Demand and
the Supply of National Saving
(3 of 4)
•An increase in the demand for investment (I ) pushes
up the real interest rate and encourages more saving
by households.
•The higher rate of saving (and investment) leads to a
higher growth rate of potential output.
Increases in Investment Demand and
the Supply of National Saving
(3 of 4)
•An increase in the demand for investment (I ) pushes
up the real interest rate and encourages more saving
by households.
•The higher rate of saving (and investment) leads to a
higher growth rate of potential output.
Copyright © 2023 Pearson Canada Inc. 8 -65Copyright © 2023 Pearson Canada Inc. 8 -65
Figure 10- 3(ii) Increases in Investment Demand
and the Supply of National Saving
(4 of 4)
Changes in the supply of national saving or the demand for investment will change the equilibrium real interest
rate and the rate of growth of potential output.
Figure 10- 3(ii) Increases in Investment Demand
and the Supply of National Saving
(4 of 4)
Changes in the supply of national saving or the demand for investment will change the equilibrium real interest
rate and the rate of growth of potential output.
Copyright © 2023 Pearson Canada Inc. 8 -66
Figure 10- 4 Cross- Country Investment and Growth
Rates, 1961‒2019
•The figure shows a positive relationship between investment
rates and growth rates, as predicted by our model.
(Source: Based on author’s calculations using data from the World Bank, www.worldbank.org.)
Figure 10- 4 Cross- Country Investment and Growth
Rates, 1961‒2019
•The figure shows a positive relationship between investment
rates and growth rates, as predicted by our model.
(Source: Based on author’s calculations using data from the World Bank, www.worldbank.org.)
Copyright © 2023 Pearson Canada Inc. 8 -67
The “Neoclassical” Growth Model
•The aggregate production function:
GDP = F
T(L, K, H)
–L= labour
–K= physical capital
–H= human capital
–T= technology
•The notation F
Tindicates that the function relating L,
K, and Hto GDP depends on the state of technology.
The “Neoclassical” Growth Model
•The aggregate production function:
GDP = F
T(L, K, H)
–L= labour
–K= physical capital
–H= human capital
–T= technology
•The notation F
Tindicates that the function relating L,
K, and Hto GDP depends on the state of technology.
Copyright © 2023 Pearson Canada Inc. 8 -68
Properties of the Aggregate Production
Function
•Key assumptions:
–the aggregate production function displays
diminishing marginal returns when any one of the
factors is increased on its own.
–constant returns to scale when all factors are
increased together.
•For simplicity, we will assume that human capital and
physical capital can be combined into a single variable
called capital and that technology is held constant.
Properties of the Aggregate Production
Function
•Key assumptions:
–the aggregate production function displays
diminishing marginal returns when any one of the
factors is increased on its own.
–constant returns to scale when all factors are
increased together.
•For simplicity, we will assume that human capital and
physical capital can be combined into a single variable
called capital and that technology is held constant.
Copyright © 2023 Pearson Canada Inc. 8 -69Copyright © 2023 Pearson Canada Inc. 8 -69
Figure 10- 5(i) The Aggregate Production Function
and Diminishing Marginal Returns
(1 of 2)
With one input held constant, the other input has a declining average and marginal product.
Figure 10- 5(i) The Aggregate Production Function
and Diminishing Marginal Returns
(1 of 2)
With one input held constant, the other input has a declining average and marginal product.
Copyright © 2023 Pearson Canada Inc. 8 -70Copyright © 2023 Pearson Canada Inc. 8 -70
Figure 10- 5(ii) The Aggregate Production Function
and Diminishing Marginal Returns
(2 of 2)
With one input held constant, the other input has a declining average and marginal product.
Figure 10- 5(ii) The Aggregate Production Function
and Diminishing Marginal Returns
(2 of 2)
With one input held constant, the other input has a declining average and marginal product.
Copyright © 2023 Pearson Canada Inc. 8 -71
Economic Growth in the Neoclassical
Model
(1 of 3)
1.Labour-Force Growth
–In the Neoclassical model with diminishing marginal
returns, increases in population (with fixed capital) lead
to increases in GDP but an eventual decline in material
living standards.
2.Physical and Human Capital Accumulation
–Capital accumulation leads to improvements in material
living standards, but because of the law of diminishing
returns, these improvements become smaller with each
additional increment of capital.
Economic Growth in the Neoclassical
Model
(1 of 3)
1.Labour-Force Growth
–In the Neoclassical model with diminishing marginal
returns, increases in population (with fixed capital) lead
to increases in GDP but an eventual decline in material
living standards.
2.Physical and Human Capital Accumulation
–Capital accumulation leads to improvements in material
living standards, but because of the law of diminishing
returns, these improvements become smaller with each
additional increment of capital.
Copyright © 2023 Pearson Canada Inc. 8 -72
Economic Growth in the Neoclassical
Model
(2 of 3)
3.Balanced Growth with Constant Technology
–If capital and labourgrow at the same rate, GDP will
increase.
–In the Neoclassical growth model with constant returns
to scale, such balanced growth will not lead to
increases in per capita outputand therefore will not
generate improvements in material living
standards.
Economic Growth in the Neoclassical
Model
(2 of 3)
3.Balanced Growth with Constant Technology
–If capital and labourgrow at the same rate, GDP will
increase.
–In the Neoclassical growth model with constant returns
to scale, such balanced growth will not lead to
increases in per capita outputand therefore will not
generate improvements in material living
standards.
Copyright © 2023 Pearson Canada Inc. 8 -73
Economic Growth in the Neoclassical
Model
(3 of 3)
4.The Importance of Technological Change
–Technological change is assumed to be exogenous.
–New knowledge can contribute to the growth of
potential output, even without capital accumulation or
labour- force growth.
–Embodied technical change ‒ technological
improvements are contained in the new capital goods.
Economic Growth in the Neoclassical
Model
(3 of 3)
4.The Importance of Technological Change
–Technological change is assumed to be exogenous.
–New knowledge can contribute to the growth of
potential output, even without capital accumulation or
labour- force growth.
–Embodied technical change ‒ technological
improvements are contained in the new capital goods.
Copyright © 2023 Pearson Canada Inc. 8 -74
Should Workers Be Afraid of
Technological Change?
•Fear of widespread unemployment caused by technical
change is unfounded.
•As long as labour markets continue to adjust to changes
in the demand and supply for labour, the overall level of
employment will grow in line with the population,
independent of the rate of technological change.
•If overall technological progress leads to an increased
demand for skilled workers, the workers most able to
adapt to changing economic conditions are the ones
most likely to prosper unlike those without requisite
skills.
Should Workers Be Afraid of
Technological Change?
•Fear of widespread unemployment caused by technical
change is unfounded.
•As long as labour markets continue to adjust to changes
in the demand and supply for labour, the overall level of
employment will grow in line with the population,
independent of the rate of technological change.
•If overall technological progress leads to an increased
demand for skilled workers, the workers most able to
adapt to changing economic conditions are the ones
most likely to prosper unlike those without requisite
skills.
Copyright © 2023 Pearson Canada Inc. 8 -75
10.3Economic Growth: Advanced
Theories
•Endogenous Technological Change
–Research has established that technological change is
responsive to economic signals (prices and profits); it is
endogenousto the economic system.
–Growth is achieved through costly, risky, innovative
activity that often occurs in response to economic
signals.
Learning by Doing
Knowledge Transfer
Market Structure and Innovation
Shocks and Innovation
10.3Economic Growth: Advanced
Theories
•Endogenous Technological Change
–Research has established that technological change is
responsive to economic signals (prices and profits); it is
endogenousto the economic system.
–Growth is achieved through costly, risky, innovative
activity that often occurs in response to economic
signals.
Learning by Doing
Knowledge Transfer
Market Structure and Innovation
Shocks and Innovation
Copyright © 2023 Pearson Canada Inc. 8 -76
Increasing Marginal Returns
•Neoclassical theories of economic growth assume
that investment in capital is subject to diminishing
marginal returns.
•Some research suggests the possibility of increasing
returns that remain for considerable periods of time.
•The sources of increasing returns fall into one of two
categories:
–Market-development costs
–The Economics of Ideas
Increasing Marginal Returns
•Neoclassical theories of economic growth assume
that investment in capital is subject to diminishing
marginal returns.
•Some research suggests the possibility of increasing
returns that remain for considerable periods of time.
•The sources of increasing returns fall into one of two
categories:
–Market-development costs
–The Economics of Ideas
Copyright © 2023 Pearson Canada Inc. 8 -77
10.4 Are There Limits to Growth?
•Resource Exhaustion
–The years since WWII have seen a rapid acceleration
in the consumption of the world’s resources,
particularly fossil fuels and basic minerals.
–The world’s current resources and its present capacity
to cope with pollution and environmental degradation
are insufficient to accomplish the rise in global living
standards with present technology.
–Most economists agree that absolute limits to growth,
based on the assumptions of constant technology and
fixed resources, are not relevant.
10.4 Are There Limits to Growth?
•Resource Exhaustion
–The years since WWII have seen a rapid acceleration
in the consumption of the world’s resources,
particularly fossil fuels and basic minerals.
–The world’s current resources and its present capacity
to cope with pollution and environmental degradation
are insufficient to accomplish the rise in global living
standards with present technology.
–Most economists agree that absolute limits to growth,
based on the assumptions of constant technology and
fixed resources, are not relevant.
Copyright © 2023 Pearson Canada Inc. 8 -78
Resource Exhaustion
•Technology changes continually, as do available
stocks of resources.
•Advances in technological knowledge bring can
increase resource efficiency.
•Technology is constantly advancing, and many things
that seemed impossible a generation ago will be
commonplace a generation from now.
•Such technological advance makes any absolute
limits to economic growth less likely.
Resource Exhaustion
•Technology changes continually, as do available
stocks of resources.
•Advances in technological knowledge bring can
increase resource efficiency.
•Technology is constantly advancing, and many things
that seemed impossible a generation ago will be
commonplace a generation from now.
•Such technological advance makes any absolute
limits to economic growth less likely.
Copyright © 2023 Pearson Canada Inc. 8 -79
Environmental Degradation
•Conscious management of pollution was unnecessary
when the world’s population was 1 billion people, but
such management has now become a pressing
matter.
•Conclusion
–Growth can help the world address many problems.
But further growth must be sustainable growth, which
should be based on knowledge- driven technological
change.
Environmental Degradation
•Conscious management of pollution was unnecessary
when the world’s population was 1 billion people, but
such management has now become a pressing
matter.
•Conclusion
–Growth can help the world address many problems.
But further growth must be sustainable growth, which
should be based on knowledge- driven technological
change.
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