5. The rule of 70 The lifetime real income of most workers is determined by the

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5. The rule of 70 The lifetime real income of most workers is determined by the real compensation they receive for their labor. (Even if a worker earns investment income later in life, it is typically the result of saving from employee compensation earlier in life.) Labor productivity growth, which tracks growth in real compensation, is, therefore, a better indicator of changes in standards of living than GDP growth or even growth in GDP per capita. GDP equals hours worked times labor productivity. This means that growth in GDP (defined in terms of percentage change) is approximately equal to growth in hours worked plus growth in labor productivity. Even if labor productivity and average hourly compensation stay constant, GDP in an economy could grow because of growth in hours worked. GDP per capita can also grow, even if the productivity stays the same. Hours worked might go up as people who did not work before enter the labor force. In this case, GDP and GDP per capita would grow, but the average hourly compensation paid per hour worked would stay constant. Because it is proportional to growth in real wages, growth in labor productivity is the best indictor of changes in standards of living. Economists use the rule of 70 to quickly calculate the number of years required for a variable to double at a given growth rate. If the variable grows at the rate x% per year, then 70 divided by x (drop the percent) tells you the number of years it takes for this variable to double. You can use this kind of calculation to show the difference between labor productivity growth of 1.4% versus 2.5%. At a growth rate of 1.4% per year, labor productivity (and wages) will double every 50 years because 70 divided by 1.4 is about 50, A growth rate of 2.5% will double labor productivity every 28 years because 70 divided by 2.5 equals 28. If the average employee compensation grew at the rate of 3.5% per year, t will take -years for it to double. In the year 2000, average hourly compensation in the private business sector was about $37 per hour worked (measured in the purchasing power of 1996 dollars). If labor productivity grew at the rate of 1.4% per year, the average hourly compensation in the year 2100 (still measured in 1996 dollars per hour worked) would be In the year 2000, average hourly compensation in the private business sector was about $37 per hour worked (measured in the purchasing power of 1996 dollars). If labor productivity grew at the rate of 3.5% per year, average hourly compensation in the year 2100 (still measured in 1996 dollars per hour worked) would be

Explanation / Answer

It will take 70/3.5 = 20 years to double use rule of 70. The productivity in 100 years will be x(1.014)^100 = 4 times the original productivity. Since average hourly compensation is proportional to labor productivity so hourly compensation will be = 37*4 = $148 With growth in labor productivity =3.5%. Productivity in 100 years will be x(1.035)^100 = 31.2 times. So average hourly compensation will be 37*31.2 = $1154.4

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