Chapter 12 (ME)

GDP Per Person

  • The standard of living in country is related to:

    • How much an economy can produce is measured by GDP

  • Real GDP per capita, or real GDP per person, to measure the standard of living across countries

    • Real GDP / # of population

    • More accurate snapshot of the economy relative to just GDP

    • If we want living standards for the average person to increase, we need to focus on how to increase GDP per capita 


Level of real GDP per capita

  • Good gauge of economic prosperity 

Over time → growth of real GDP per capita

  • Good gauge of economic progress

  • Ex: world: 3.2%

US: 2.7%

Developing: 4.2%

Productivity 

How to Measure Productivity?

  • This ability depends on on productivity, the average quantity of g&s produced per unit of labor input

    • Y = real GDP = output = production

    • L = labor

    • Y/L = output per labor/worker = productivity = average labor productivity 

  • When a nation’s workers are very productive, real GDP is large and incomes are high

  • When productivity grows rapidly, so do living standards

    • Y/L increases → income increases → living standards increase 

Determinants of Productivity

1. Physical Capital Per Worker

  • The stock of equipment and structures used to produce g&s called [physical] capital, denoted K

K/L increases → Y/L increases

  • Used to expand the production process and increase future production

Components of Physical Capital


2. Human Capital Per Worker

  • The knowledge and skills that workers acquire through education, training, and experience, denoted H

H/L increases → Y/L increases

3. Natural Resources Per Worker

  • The inputs into production that nature provides, (ex: land, mineral deposits), denoted N

  • Other things equal, more N allows a country to produce more Y

N/L increases → Y/L increases

  • Some countries are rich because they have abundant natural resources (e.g., Saudi Arabia has lots of oil)

  • But countries need not have much N to be rich (e.g., Japan imports the N it needs)

4. Technological Knowledge 

  • Society’s understanding of the best ways to produce goods and services, denoted A

    • Technological progress does not only mean a faster computer, or a smaller cell phone.

    • It means any advance in knowledge that boosts productivity (allows society to get more output from A)

    • Ex: Henry Ford and the assembly line

      • Not only change the auto industry, but also change the production of a country 

Boosting Productivity Growth

Stretching Natural Resources

  • 200 years ago, Malthus argued  that population growth would strain society’s ability to provide for itself (From “An Essay on the Principle of Population, published in 1826)

  • Since then, the world population has increased

  • If Malthus was right, living standards would have fallen 



  1. Summarize the idea of Paul Ehrlich and discuss whether he was right or not.

His idea was that there are not enough natural resources to keep the population alive for a long period of time, therefore many people would have to die. He was wrong because certain products get cheaper over time, meaning more people could buy them, and he underestimated the nature of natural resources. 



  1. In today’s world, where technological advancements have improved agricultural productivity and resource management, do you think Malthus’ predictions are still relevant?

Malthus’ predictions are not relevant anymore due to the technological innovations that have occurred since his time, as well as the change in society’s structure. 



  • Malthus failed to account for technological progress and productivity growth

  • Diluting the Capital Stock

    • Bigger population = higher L = lower K/L = lower productivity and living standards 

    • Applies to H and K

    • Fast population growth = more children = greater strain on educational system

  • Promoting Technological Progress

    • More people = more scientists, inventors, engineers = more frequent discoveries = faster technological progress and economic growth 

    • Evidence from Micheal Kramer (Economist, Nobel Prize 2019)

      • Over the curse of human history

        • Growth rates increases as the worlds’ population increased 

        • More populated regions grew faster than less populated ones 

Are Natural Resources a Limit to Growth?

  • Some argue that population growth is depleting the Earth’s non-renewable resources

    • → This will limit growth in living standards

Increase in Human Capital per Worker (H/L)

  • Human capital per worker can be viewed as the average skill level of workers within an economy

  • To increase human capital, we need to increase the knowledge and skills of the workers (or at least most of them)

    • Education ← public education provides a large subsidy to H investment

    • Health and Nutrition

    • Worker Training Programs

    • Diversity and Inclusivity Training

Increase in Physical Capital per Worker

  • As physical capital per worker increases, productivity tends to increase ( K/L increase → Y/L increase)

    • Investment spending is the spending by firms to purchase physical capital (Recall Ch 10).

    • By making it easy or cheaper to invest, a country can increase physical capital and productivity.

  • Savings and Investment

    • Savings and investment go hand-in-hand.

    • When companies want to invest in the purchase of physical capital, they typically need to borrow money.

      • That money needs to come from somewhere → it comes from other people’s savings!

      • Any policies that increase savings will also increase investment (which is the goal!)

      • Save more → I increase → K increase → Y increase

  • Directly influence the amount of investment occurring in the economy

  • Investment from abroad

    • If domestic residents cannot afford to invest, foreign residents and companies may be able to

  • Two types of foreign investment

    • Foreign Direct Investment (FDI): Capital is owned and operated by a foreign entity 

      • Beneficia; in poor countries that cannot generate enough savings to fund I 

      • Ex: BMW (Germany) opening in US

    • Foreign Portfolio Investment (FPI): Capital investment financed with foreign money but operated by domestic residents 

      • Ex: BMW invests in Microsoft stock

***Diminishing Returns to Physical Capital 

  • While increasing the capital stock does increase productivity, the effect is not constant

  • Diminishing returns to physical capital 

  • As the capital stock per worker increases, each additional piece of capital provide a smaller amount of benefit 

  • (graph)

  • Higher saving rate 

    • Implies a higher productivity (Y/L) – “Level”

    • Does NOT imply higher productivity (Y/L) growth because diminishing returns  

Catch-Up Effect

  • Poor economies will grow faster than wealthier economies

  • Example

    • Over 1960-1990, the US and S Korea devoted a similar share of GDP to investment, so you might expect they would have similar growth performance 

      • But growth was >6% in Korea and only 2% in the US

      • In 1960, K/L was far smaller than in the US, hence Korea grew faster 

Increase in Technological Knowledge 

  • Technological progress is the main reason why living standards rise over the long run

  • Knowledge/Ideas can be shared freely, increasing the productivity of many.

  • Policy to promote technological progress

    • Patent laws

    • Tax incentives or direct support for private sector R&D

    • Grants for basic research at universities