For example, in the fourth quarter of 1994, RGDP was 6691.3 billion chained 1992 dollars, but by the fourth quarter of 1995 it had increased to 6776.5 billion. Therefore, RGDP = 6776.5-6691.3=85.2 billion 1992 dollars. In turn the rate of growth of GDP was 85.2/6691.3 = 1.27% in 1995.
The growth rate of RGDP per capita is the difference between the growth rate of RGDP and the growth rate of the population. If the population is growing at about 9/10 of one percent, then the growth of RGDP per capita would have been 1.27-0.9 = 0.37 of a percent.
Smith taught us that labor productivity is the most important, direct economic determinant of the standard of living. For the country as a whole, labor productivity is the output per person employed in the work force. In the fourth quarter of 1995, 98,436,000 people were working in the United States, so productivity, in that quarter, was 6776.5 billion divided by 98,436,000 = 68841.68 chained 1992 dollars.
News discussions are often careless about the difference between the levels of production, productivity and population and the rates of growth of these measures. For example, the rate of growth of labor productivity has been lower, on the average, since 1975 than it was during 1945-75. Does that mean "productivity is lower?" No, indeed -- productivity has risen by over 20% between 1975 and 1992; but it has risen at a slower rate than it did during the earlier period.
We can visualize economic growth as a shift in the Production Possibility Frontier. In the figure shown below, growth means the economy is able to produce more of everything.
Adam Smith's theory of economic growth had two parts:
Thomas Malthus gave the pessimist's response to Smith's optimism. He saw two problems that would break the virtuous circle:
Malthus observed that production requires land as well as labor. Population growth increases the labor supply, but not the supply of land. Labor is a variable input in Malthus' long run, and land is a fixed input. We recall the Principle of Diminishing Marginal Productivity: as the quantity of the variable input increases, the marginal productivity of the variable input declines. Moreover, as we recall from the chapter on diminishing marginal productivity, it is the marginal productivity of labor that determines the wage. Therefore, as population grows, the marginal productivity of labor and the wage decline. Malthus thought this would continue until the wage is pushed down to "subsistence."
We may visualize this as follows.
An economist named Nassau Senior wrote "That the powers of Labor, and of the other instruments that produce wealth, may be indefinitely increased by using their Products as the means of further production." This is a pretty clear statement that investment, in and of itself, increases output.
Why should investment, in and of itself, increase output per worker? The Austrian economists, such as Eugen von Bohm-Bawerk, had an answer to that. They claimed that "roundabout" production is more productive than direct or simple production.
Senior also pointed out that people are impatient -- people "prefer" to have goods and services now rather than in the future. That's time preference: the time that people prefer is now, not in the future. That limits the amount they are willing to save and invest.
Roy Harrod, a British economist, argued that there might be an imbalance between
and
This is another "stationary state" theory. So what makes people better off, in product-per-capita terms? The neoclassical economists say: innovation. This is illustrated in the following figure.
