CHAPTER 25_Principles of Economics - Production and Growth

Production and Growth

Economic Growth Around The World

Productivity: Its Role And Determinants

• Productivity is crucial because:
  • High worker productivity leads to large real GDP and high incomes.
  • Rapid productivity growth leads to rapidly improving living standards.
• Determinants of productivity:
  • Physical capital per worker
  • Human capital per worker
  • Natural resources per worker
  • Technical knowledge

The Production Function

• The production function is expressed as: $Y = AF(L, K, H, N)$
  • $Y$ = quantity of output
  • $L$ = quantity of labor
  • $K$ = quantity of physical capital
  • $H$ = quantity of human capital
  • $N$ = quantity of natural resources
  • $F()$ = function showing how inputs are combined to produce output
  • $A$ = level of technology; improvements in $A$ allow more output $Y$ to be produced from any given combination of inputs.
• The production function exhibits constant returns to scale.
  • Changing all inputs by the same percentage causes output to change by that percentage.
  • $xY = AF(xL, xK, xH, xN)$
  • Output per worker: $Y/L = AF(1, K/L, H/L, N/L)$

Economic Growth And Public Policy

• Government policy can encourage saving and investment to raise productivity and living standards.
• GDP growth is not indefinite due to diminishing returns to capital.
• In the long run, a higher saving rate leads to higher levels of productivity and income but not to higher growth in these variables
• The catch-up effect: it is easier for a country to grow fast if it starts out relatively poor because of diminishing returns.

Other Ways To Increase Productivity

• Investment from abroad:
  • Foreign direct investment: capital investment owned and operated by a foreign entity.
  • Foreign portfolio investment: capital investment financed with foreign money but operated by domestic residents.
• Education
  • Each year of education can significantly increase a person’s wage.
  • Can have positive externalities
  • Need to take into account opportunity cost
• Health and nutrition
  • Investment in human capital – healthier workers are more productive
• Property rights and political stability
  • Protect people’s ability to exercise authority over the resources they own
  • Implement an efficient court system
  • Root out corruption and fraud in government
  • Ensure political stability
• Free trade
  • Choose outward-oriented policies over inward-oriented ones, i.e., remove restrictions on trade and foreign investment and promote integration with the world economy
• Research and development
  • Technological progress is the main driver of long-run increases in living standards
  • Can be promoted through patent system
• Population growth
  • Stretching natural resources
  • Diluting the capital stock
    • Lower GDP per worker
    • Greater burden on education system and lower educational attainment
  • Many developing countries try to control population growth through government policies, birth control education and availability and the promotion of female literacy
  • Promoting technological progress. More people means
    • more scientists, inventors, engineers
    • more frequent discoveries
    • faster technological progress

Review of Productivity Concepts

• Determinants of productivity:
  • $K/L$ (physical capital per worker)
  • $H/L$ (human capital per worker)
  • $N/L$ (natural resources per worker)
  • $A$ (technological knowledge)
• Policies to boost productivity:
  • Encourage saving and investment, to raise $K/L$.
  • Encourage investment from abroad, to raise $K/L$.
  • Provide public education, to raise $H/L$.
  • Patent laws or grants, to increase $A$.
  • Control population growth, to increase $K/L$.

Summary

• There are great differences across countries in living standards and growth rates.
• Productivity (output per unit of labor) is the main determinant of living standards in the long run.
• Productivity depends on physical and human capital per worker, natural resources per worker, and technological knowledge.
• Policies can affect the following, each of which has important effects on growth:
  • Saving and investment
  • International trade
  • Education, health and nutrition
  • Property rights and political stability
  • Research and development
  • Population growth
• Because of diminishing returns to capital, growth from investment eventually slows down, and poor countries may “catch up” to rich ones.