Week 2

An Overview of Long-Run
Economic Growth
3.1 Introduction
This week, we learn
• some facts related to economic growth that later we will seek to
explain,
• how economic growth has dramatically improved welfare around
the world,
• how this growth is a relatively recent phenomenon,
• some tools used to study economic growth, including how to
calculate growth rates,
• why a “ratio scale” makes plots of per capita GDP easier to
understand.
Motivation: Ethiopia today or U.S. in 1900?

• Life expectancy is less than 50 years

• 1 every 10 infants dies before the age of 1
• More than 90% of households have no electricity, refrigerator,
telephone, or car
• Fewer than 10% of adults have completed high school
Mo;va;on: The Power of Economic Growth in the U.S.

Life expectancy
• In 1900 = 50 years – today = 78 years
• The richest man in the world in the mid 1800s – the great
European financier Nathan Rothschild – died from an infection
that $10 antibiotics would cure today

Education
• A typical university graduate today will earn a lifetime income
about twice that of her or his parents
Motivation: Economic Growth is not uniform across countries or over time
Growth is a recent economic phenomenon.
The study of economic growth explains differences between
countries and differences over time.
• why is GDP in the United States higher than in Bangladesh?
• why have standards of living increased in the United States
over time, despite the severity of the recent recession?

Even if a country is experiencing a recession, countries with

higher levels of GDP still have higher standards of living.
• Economic growth and standards of living are not a short-term
result
Motivation: Why Is Economic Growth Important?

A 1 percent change in annual Hypothetical GDP Values

growth appears small, but it may

(in billions of dollars)
280

lead to large differences in the 260

240

levels of output over time. 220

200

Consider a 100-year period: 180

160

• Country A and B begin at the 140

same level of GDP ($100 billion).

120

100
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

• Country A grows at 1 percent Country A Country B

each year.
• Country B grows at 0.25 percent
each year.
3.2 Growth Over the Very Long Run
Sustained increases in standards of living are a recent phenomenon:
• The [irst agricultural revolution was about 10,000 years ago.
• Yet, only in the last 200–300 years has modern economic
growth appeared.
Economic growth emerges in different places at different times for
many reasons. Some results of this are:
• Standards of living have diverged dramatically.
• Per capita GDP differs remarkably around the world.
Growth Over the Very Long Run
Growth Over the Very Long Run
3.3 Modern Economic Growth
Looking over the past 150 years: from 1870 to 2018, United States
real per capita GDP rose by more than 15-fold.
Assuming this rate of growth continues, a typical university
graduate today will earn a lifetime income about twice that of his or
her parents.
Modern Economic Growth
The Definition of Economic Growth
Growth of per capita GDP
• The exact rate of change of per capita GDP
A percentage change
• The change between two periods divided by the value of the
variable in the initial period
Percentage change in GDP between period t and t+1:

where g bar (𝑔) is the associated constant growth rate.

̅
Example: Quarterly GDP growth
Time Real GDP, Growth
period £million rate
2019 Q4 544733
2020 Q1 529031 -2.9%
2020 Q2 428307 -19.0%
2020 Q3 497401 16.1%

Source: ONS
2020 Q4 502253 1.0%
𝑦!"!"#$ − 𝑦!"$%#& 529031 − 544733
#𝑔 = −1= − 1 = −0.029
𝑦!"$%#& 544733

'!"!"#! ('!"!"#$ &!)*"+(,!%"*$

#𝑔 = '!"!"#$
−1= ,!%"*$
− 1 = −0.190
Example: Population Growth—1
Population growth evolves the same way:

Intuitively, tomorrow’s population in time period t+1 depends on

today’s population in period t.
If equation (1) is true in time t, it also applies to time t+1. It follows
that
Population Growth—2
But, equation (1) gives us the value for
So, we can plug (1) into (2) to get

And, we could continue this process for any number of time periods,
until we recognize the pattern:
Population Growth—3
Given values for 𝐿- and n̅ , what will the world population be 100 years
from now? Evaluating equation (5) at t = 100, we get

3 $"" 𝐿"
𝐿$"" = (1 + 𝑛)

With 𝐿" = 6billion, 𝑛3 = 0.02

1.02$"" ×6 ≈ 7.24×6 ≈ 43.5billion
• this is helpful for understanding growth, the numbers are not realistic.
• Most demographers expect population growth rates to fall to zero or
even turn negative during the coming century.
The Constant Growth Rule
The constant growth rule states that

(6)

• where
• 𝐭 is the time period,
• 𝐲𝐭 is the value of variable 𝑦 in time 𝑡,
• 𝒚𝟎 is the initial value of variable 𝑦 in period 0,
• is the constant growth rate.
Population over Time
The Rule of 70

The Rule of 70: Notes:

If y grows at a rate of g percent Small differences in growth
per year, then the number of rates result in large
years it takes y to double is differences over time.
approximately equal to 70/g. The time it takes to double
only depends on the growth
rate and not on the initial
value.
The Rule of 70
Numerical examples:
• 1×1.01+" ≈ 2.0068 1×1.02*, ≈ 1.9999
70/1=70 70/2=35
Math:
𝑦- = 2×𝑦"
1 + 𝑔̅ - 𝑦" = 2×𝑦"
1 + 𝑔̅ - = 2
t×ln 1 + 𝑔̅ = ln 2
Note that
t×𝑔# ≈ ln 2 ≈ 0.7
70 ln(1 + 𝑔)̅ ≈ 𝑔̅
𝑡=
100×𝑔̅
The Ratio (Logarithmic) Scale
A plot where equally spaced tick marks on the vertical axis are
labeled consecutively with numbers that exhibit a constant ratio:
• When doubling, we want this constant ratio to be "2."
• So, on the y-axis, instead of "1, 2, 3, 4" we have "1, 2, 4, 8", or in
our case, "6, 12, 24, 48."

When plotted on a ratio scale, a variable that grows at a constant

rate will be a straight line.
Population over Time, Revisited
U.S. GDP on a Ratio Scale
On a ratio scale; if growth rates are rising, the slope will be
increasing; if the growth rate is constant, it will be a straight line.
Per capita GDP in the United States has grown at approximately 2
percent per year over the past 150 years.
• This outcome is easy to see using a ratio scale,
• Approximately linear.
Per Capita GDP in the United States, Ratio Scale
Per Capita GDP in the United Kingdom, Ratio Scale
Calcula;ng Growth Rates
n Begin with the constant growth rule:

n Now, solve for .

n Divide both sides by 𝑦0:

n Raise both sides to the 1/𝑡 power:

n Subtract 1 from both sides:

Calculating Growth Rates - Example
United States per capita GDP :
n 1870: $3,600.
n 2018: $61,000.
n 148 years.

$
61000 $&) $
𝑔̅ = −1= 16.9444$&) − 1 ≈ 1.01934 − 1 ≈ 0.02
3600
3.4 Modern Growth around the World - 1 : Per Capita GDP since 1870
3.4 Modern Growth around the World - 2
After World War II, growth in Germany and Japan were similar, in that
they both accelerated.
• As we see in the previous figure, over time, the acceleration slows.
Convergence:
• Poorer countries will grow faster to “catch up” to the level of income
in richer countries.
Argentina had accelerated growth until 1980 and then slowed
considerably.
• China and India have had the reverse pattern.
Per Capita GDP since 1870 in Europe and the U.S. - 1
Per Capita GDP since 1870 in Europe and the U.S. - 2
Per Capita GDP since 1950 in East Asia and the U.S.
A Broad Sample of Countries
Over the period 1960–2017:
• Some countries have exhibited a negative growth rate.
• Other countries have sustained nearly 7% growth rates.
• Most countries have sustained about 2% growth rates.
Small differences in growth rates result in large differences in
standards of living.
Levels and Growth Rates of Per Capita GDP
Case Study: People versus Countries
• A major reason for changes:
• Since 1960:
• Economic growth in China and
• The bulk of the world’s population is
India
substantially richer.
• These two countries account for 40
• The fraction of people living in
percent of the world population.
poverty has fallen.
3.5 Some Useful Properties of Growth Rates
Growth rates of ratios, products, and powers follow several simple
rules.
Growth rates obey mathematical operations that are a level simpler
than the operation on the original variable.
• Variables divided à growth rates subtracted
• Variables multiplied à growth rates added
• Variable taken to a power numberà growth rate multiplied by
that number
 Some Useful Properties of Growth Rates - 1
• Suppose two variables 𝑥 and 𝑦 have average annual growth rates of 𝑔𝑥
and 𝑔𝑦, respectively.
• Assume also that gz is the average annual growth rate of 𝑧.
Then the following rules apply:
 Some Useful Proper;es of Growth Rates - 2
• These rules are approximations.
• Consider 𝑧 = 𝑥 × 𝑦

𝑧-/$ 𝑥-/$ 𝑦-/$

1 + 𝑔̅. = = = 1 + 𝑔̅0 1 + 𝑔̅'
𝑧- 𝑥- 𝑦-
1 + 𝑔̅. = 1 + 𝑔̅0 + 𝑔̅' + 𝑔̅0 𝑔̅'
𝑔̅. ≈ 𝑔̅0 + 𝑔̅'
Because 𝑔̅0 𝑔̅' is very small.
• If both growth rates are 2%, then 𝑔̅0 𝑔̅' = 0.02 D 0.02 = 0.0004 ≈ 0
• Thus, it is 0.04%, small.
Examples of Growth Rate Calculations
U.S. Population, GDP, and Per Capita GDP

&'(
Per capita GDP=
()*+,-./)0
Growth Rules in a Famous Example

n Applying rules of growth rates to a Cobb-Douglas

production function:
n Original output equation:

n Use multiplication rule to get:

n Use exponent rule to get:

3.6 The Benefits and Costs of Economic Growth
The benefits of economic growth
• Improvements in health
• Higher incomes
• Increase in the variety of goods and services
Costs of economic growth include:
• Environmental problems
• Income inequality across and within countries
• Loss of certain types of jobs
Economists generally have a consensus that the benefits of
economic growth outweigh the costs.
3.7 A Long-Run Roadmap
The next few weeks examine the following:
• Lecture 3: How can we explain differences in income levels
across countries with the production model?
• Lecture 4: Develops the Solow growth model
• Lecture 5: Knowledge and human capital a driver of economic
growth?
Also part of the long-run discussion is:
• Lecture 6: The labor market, wages, and unemployment in the
long run
• Lecture 7: Determinants of long-run inflation