Technological Change, Creative Destruction, and Rising and Falling Firms

Introduction to Creative Destruction

Economic history is marked by the rise and fall of firms due to technological change and market competition. The case of Blockbuster Video illustrates how technological innovation can disrupt established businesses.

• Creative Destruction: The process by which new innovations cause old technologies, firms, or industries to become obsolete.

• Example: Blockbuster Video dominated video rentals in the 1980s and 1990s but was displaced by new services like Netflix due to technological advancements and changing consumer preferences.

• Application: Modern firms such as Apple and Facebook must continually innovate to avoid a similar fate.

Economic Growth

Understanding Economic Growth

Economic growth refers to the sustained increase in a country's output of goods and services over time, typically measured by real GDP per capita. Growth is not guaranteed and has varied across countries and historical periods.

• Key Question: Why do some countries achieve rapid increases in living standards while others stagnate?

• Model of Economic Growth: Economists use models to analyze the factors that drive long-term growth.

Growth Over Time and Around the World

Historical Patterns of Growth

For most of human history, living standards remained largely unchanged. Significant economic growth began only in the last two centuries.

• Pre-Industrial Era: Standard of living was essentially constant for centuries.

• Modern Growth: The last 200 years have seen unprecedented increases in real GDP per capita.

Annual Growth Rates for the World Economy

Growth rates in real GDP per capita have varied significantly over time, with notable acceleration after the Industrial Revolution.

• Impact of Growth Rates: Even small differences in annual growth rates can lead to large differences in living standards over time due to compounding.

• Example: Over 50 years, a 1.61% growth rate leads to a 122% increase in GDP per capita, while a 2.2% rate leads to a 197% increase.

The Industrial Revolution

Origins and Impact

The Industrial Revolution marked the beginning of sustained economic growth, starting in England around 1750 with the application of mechanical power to production.

• Definition: The Industrial Revolution was a period of rapid industrialization and technological innovation.

• Key Change: Shift from human and animal labor to mechanical power, enabling mass production and higher productivity.

• Spread: The revolution spread from England to other countries such as the United States, France, and Germany.

Why Did the Industrial Revolution Begin in England?

Institutional changes, such as the Glorious Revolution of 1688, played a crucial role in setting the stage for economic growth in Britain.

• Property Rights: The British Parliament gained power over the monarchy, ensuring property rights and an independent court system.

• Incentives: Secure property rights and limited arbitrary taxation encouraged entrepreneurs to invest and innovate.

Key Concepts in Economic Growth

Measuring Economic Growth

• Real GDP per Capita: The most common measure of a country's standard of living, calculated as total real GDP divided by the population.

• Formula:

Labor Productivity

Labor productivity is the amount of goods and services produced by one worker or one hour of work. It is a key determinant of economic growth.

• Determinants:

  • Quantity of capital per hour worked

  • Level of technology

• Capital: Manufactured goods used to produce other goods and services (e.g., machinery, tools).

• Technological Change: Improvements in the ability to produce more output with the same inputs.

Sources of Technological Change

• New machinery and equipment (e.g., steam engine, electric generators)

• Increases in human capital (education and training)

• Better organization and management of production (e.g., just-in-time systems)

The Per-Worker Production Function

Relationship Between Capital and Output

The per-worker production function shows the relationship between output per worker and capital per worker, holding technology constant.

• Diminishing Returns: Each additional unit of capital increases output by a smaller amount.

• Technological Change: Shifts the production function upward, allowing more output for the same amount of capital.

Equation:

• = Output

• = Level of technology

• = Capital

• = Labor

Economic Growth Theories

Solow Growth Model (Neoclassical Growth Theory)

Developed by Robert Solow, this model explains long-run economic growth based on capital accumulation, labor or population growth, and increases in productivity (technological progress).

• Assumption: Technological change is exogenous (outside the model).

• Prediction: Diminishing returns to capital; sustained growth requires technological progress.

New Growth Theory

This theory emphasizes the role of knowledge, innovation, and incentives in driving technological change and economic growth.

• Knowledge Capital: Nonrival and nonexcludable, leading to increasing returns at the economy-wide level.

• Role of Government: Protecting intellectual property, subsidizing research and development (R&D), and supporting education.

Institutions and Economic Growth

Importance of Institutions

Strong institutions, such as property rights, rule of law, and efficient financial systems, are essential for economic growth.

• Property Rights: Secure ownership encourages investment and innovation.

• Rule of Law: Predictable and fair enforcement of laws supports business activity.

• Financial Systems: Efficient allocation of savings to productive investments.

Catch-Up Effect and Convergence

Catch-Up Hypothesis

The catch-up effect predicts that poorer countries will grow faster than richer ones, leading to convergence in income levels over time.

• Evidence: Some high-income countries have experienced convergence, but many low-income countries have not.

• Barriers: Weak institutions, corruption, poor education and health, and political instability can prevent catch-up.

Globalization and Growth

Role of Globalization

Globalization, the process of increasing economic integration through trade and investment, has contributed to higher growth rates in many countries.

• Foreign Direct Investment (FDI): Investment by firms in production facilities in other countries.

• Portfolio Investment: Purchase of stocks and bonds issued in another country.

• Benefits: Provides capital, technology, and management expertise to developing countries.

Growth Policies

Policies to Promote Economic Growth

• Protecting property rights and the rule of law

• Investing in health and education

• Encouraging technological change (e.g., through R&D subsidies)

• Promoting savings and investment (e.g., tax incentives)

Debates and Challenges in Economic Growth

Is Economic Growth Always Good?

While growth is generally beneficial, especially for low-income countries, concerns include environmental impact, resource depletion, and cultural changes.

• Normative Issues: Some arguments against growth are based on values and preferences rather than economic analysis.

Sample Questions and Applications

Conceptual Questions

• Best Measure of Standard of Living: Real GDP per capita is the preferred measure.

• Growth and Living Standards: If real GDP grows slower than population, standard of living falls.

• Foreign Direct Investment Example: An American company building a hub in China is FDI.

Table: Example of GDP and Population

• Analysis: Country B has a higher standard of living because its GDP per capita is higher, despite having a lower total GDP.

Additional info: Some content and examples were expanded for clarity and completeness based on standard macroeconomics curriculum.