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Production and Growth

Chapter 24

Copyright 2001 by Harcourt, Inc .

All rights reserved. Requests for permission to make copies of any part ofthe

work should be mailed to:Permissions Department, arcourt !ollege Publishers,

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arcourt, +nc. items and derived items copyright #-- by arcourt, +nc.


A countrys standard of livingdepends on its ability toproduce goods and services.

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ithin a country there arelarge changes in thestandard of living over ti!e.

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In the "nited #tates over the pastcentury, average inco!e as !easuredby real $%& per person has gro'n byabout 2 percent per year.

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&roductivity refers to the a!ount ofgoods and services produced for eachhour of a 'or(ers ti!e.A nations standard of living isdeter!ined by the productivity of its'or(ers.

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The Variety of Growth Experiences

Country Period

Real GDP per

Person atBeginning of Period

Real GDP per

Person at Endof Period Growth Rate(per year)

J apan 189 !199" #1$19% #&'$ & 8&*

Bra+il 19 !199 %19 %$& & 1

,e-i.o 19 !199" 9&& 8$1& & &"

Ger/any 18" !199" 1$"'8 &1$' 1 99Canada 18" !199" 1$89 &1$8% 1$90

China 19 !199" 0" '$0" 1 91

rgentina 19 !199" 1$8& 9$90 1 "%

2nited 3tates 18" !199" '$188 &8$" 1 "04ndonesia 19 !199" " 8 '$ 0 1 %0

2nited 5ingdo/ 18" !199" '$8&% & $0& 1 ''

4ndia 19 !199" 0'" 1$90 1 '

Pa6istan 19 !199" 08" 1$09 1 '

Bangladesh 19 !199" 90 1$ 0 "8


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Economic Growth Around theWorld

)iving standards, as !easuredby real $%& per person, varysignificantly a!ong nations.

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Economic Growth Around the

World

*he poorest countries haveaverage levels of inco!e thathave not been seen in the "nited

#tates for !any decades.

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Compounding and the

ule of !"Annual gro'th rates that see! s!allbeco!e large 'hen co!pounded for!any years.Co!pounding refers to theaccu!ulation of a gro'th rate over aperiod of ti!e.

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Compounding and the

ule of !"

According to the rule of +0 , if so!evariable gro's at a rate of percentper year, then that variable doublesin appro i!ately +0- years.

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An Example of the ule of !"

/,000 invested at + percent interest peryear, 'ill double in si e in 10 years

70/ 7 = 10

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Why Producti#ity $s %o $mportant

&roductivity plays a (ey role indeter!ining living standardsfor all nations in the 'orld.

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&roductivity refers to the uantity ofgoods and services that a 'or(er canproduce fro! each hour of 'or(.

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*o understand the large differences inliving standards across countries. e!ust focus on the production of goods

and services.

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&ow Producti#ity is 'etermined

*he inputs used to produce goods and

services are called the factors ofproduction .

*he factors of production directlydeter!ine productivity.

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The (actors of Production

&hysical capital

Hu!an capitalatural resources

*echnological (no'ledge

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The (actors of Production

Capital is a produced factor ofproduction.

It is an input into the productionprocess that in the past 'as anoutput fro! the production process.

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Physical Capital

&hysical capital is the stoc( ofe uip!ent and structures that are

used to produce goods and services.*ools used to build or repair auto!obiles.

*ools used to build furniture.

3ffice buildings, schools, etc.

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&uman Capital

Hu!an capital is the econo!ists ter! forthe (no'ledge and s(ills that 'or(ers

ac uire through education, training, ande perience.

)i(e physical capital, hu!an capital raises a

nations ability to produce goods andservices.

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atural resources are inputs used inproduction that are provided by nature,

such as land, rivers, and !ineraldeposits.

4ene'able resources include trees and

forests.onrene'able resources include petroleu!

and coal.

)atural esources

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Technological *nowledge

*echnological (no'ledge is theunderstanding of the best 'ays toproduce goods and services.Hu!an capital refers to the resourcese pended trans!itting thisunderstanding to the labor force.

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The Production (unction

5cono!ists often use a productionfunction to describe the relationshipbet'een the uantity of inputs usedin production and the uantity of

output fro! production.

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Y = A F(L, K, H, N) Y 6 uantity of output

A 6 available production technologyL 6 uantity of labor

K 6 uantity of physical capitalH 6 uantity of hu!an capitalN 6 uantity of natural resources

F( ) is a function that sho's ho' theinputs are co!bined.

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A production function has constant returnsto scale if, for any positive nu!ber x ,

xY = A F(xL, xK, xH, xN)

*hat is, a doubling of all inputs causes the

a!ount of output to double as 'ell.

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&roduction functions 'ith constant returns toscale have an interesting i!plication.

#etting x = 1/L ,

Y/ L = A F(1, K/ L, H/ L, N/ L)

here7

Y/L 6 output per 'or(erK/L 6 physical capital per 'or(erH/L 6 hu!an capital per 'or(erN/L 6 natural resources per 'or(er

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The Production (unction*he preceding e uation says thatproductivity 8Y/L 9 depends on physicalcapital per 'or(er 8K/L 9, hu!an capitalper 'or(er 8H/L 9, and natural resourcesper 'or(er 8N/L 9, as 'ell as the state of

technology, 8 A 9.

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Economic Growth andPu+lic Policy

$overn!ents can do !anythings to raise productivityand living standards.

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Go#ernment Policies That aiseProducti#ity and ,i#ing %tandards

5ncourage saving and invest!ent.

5ncourage invest!ent fro! abroad5ncourage education and training.

5stablish secure property rights and!aintain political stability.

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The $mportance of %a#ing and$n#estment

3ne 'ay to raise future productivity isto invest !ore current resources in theproduction of capital.

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(a) Growth Rate 1960-1991 (b) Investment 1960-1991

%outh *orea%ingapore

-apan$srael

Canada.ra/il

West Germany0exico1nited *ingdom

)igeria1nited %tates

$ndia.angladesh

Chile

wanda

Growth Rate (percent)" 2 3 4 5 !


-apan$srael

Canada.ra/il

West Germany0exico1nited *ingdom

)igeria1nited %tates

$ndia.angladesh

Chile

wanda

Investment (percent of GDP)" " 2" 3" 4"

Growth and $n#estment

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As the stoc( of capital rises, the e traoutput produced fro! an additional unitof capital falls: this property is calleddi!inishing returns.

;ecause of di!inishing returns, anincrease in the saving rate leads tohigher gro'th only for a 'hile.

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In the long run, the higher saving rateleads to a higher level of productivityand inco!e, but not to higher gro'th in

these areas.

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*he catch

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$n#estment from A+road

$overn!ents can increase capitalaccu!ulation and long

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$n#estment from A+road

Invest!ent fro! abroad ta(es severalfor!s7

=oreign %irect Invest!entCapital invest!ent o'ned and operated by aforeign entity.

=oreign &ortfolio Invest!entInvest!ents financed 'ith foreign !oney butoperated by do!estic residents.

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Education

An educated person !ight generate ne'

ideas about ho' best to produce goodsand services, 'hich in turn, !ight entersocietys pool of (no'ledge and provide

an e ternal benefit to others.

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Education

3ne proble! facing so!e poor

countries is the brain drain

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Property ights and Political%ta+ility

Property rights refer to the ability ofpeople to e ercise authority over the

resources they o'n.An econo!y

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(ree Trade

*rade is, in so!e 'ays, a type oftechnology.

A country that eli!inates traderestrictions 'ill e perience the sa!e(ind of econo!ic gro'th that 'ould

occur after a !a>or technologicaladvance.

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(ree Trade

#o!e countries engage in . . .

. . . in'ard

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Control of Population Growth

&opulation is a (ey deter!inant of acountrys labor force.

)arge populations tend to produce greatertotal $%&.

Ho'ever, $%& per person is a better !easure

of econo!ic 'ell

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esearch and 'e#elopment

*he advance of technological (no'ledgehas led to higher standards of living.

?ost technological advance co!es fro! privateresearch by fir!s and individual inventors.

$overn!ent can encourage the develop!ent ofne' technologies through research grants, ta

brea(s, and the patent syste!.

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The Producti#ity %lowdown

*he slo'do'n in productivity gro'th isa 'orld'ide pheno!enon.

*he slo'do'n cannot be traced to thosefactors of production that are !osteasily !easured technology !ay be the

(ey.

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6"

6

26"

26

36"

36

46"

7!"879"

79"89 "

9 "893"

93"89 "

9 "89!"

9!"899"

"

The Growth in eal G'P Per Person

G r o w

t h R a

t e ( %

p e r

y e a r )

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%ummary

5cono!ic prosperity, as !easured by real$%& per person, varies substantiallyaround the 'orld.

*he average inco!e of the 'orlds richestcountries is !ore than ten ti!es that in the'orlds poorest countries.

*he standard of living in an econo!ydepends on the econo!ys ability toproduce goods and services.

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%ummary

&roductivity depends on the a!ounts ofphysical capital, hu!an capital, naturalresources, and technological (no'ledgeavailable to 'or(ers.

$overn!ent policies can influence the

econo!ys gro'th rate in !anydifferent 'ays.

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%ummary

*he accu!ulation of capital is sub>ect todi!inishing returns.

;ecause of di!inishing returns, highersaving leads to a higher gro'th for aperiod of ti!e, but gro'th 'ill eventuallyslo' do'n.

Also because of di!inishing returns, thereturn to capital is especially high in poorcountries.

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$raphical4evie'

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(a) Growth Rate 1960-1991 (b) Investment 1960-1991


-apan$srael

Canada.ra/il

West Germany0exico

1nited *ingdom)igeria

1nited %tates$ndia

.angladeshChile

wanda

Growth Rate (percent)" 2 3 4 5 !


-apan$srael

Canada.ra/il

West Germany0exico

1nited *ingdom)igeria

1nited %tates$ndia

.angladeshChile

wanda

Investment (percent of GDP)" " 2" 3" 4"

Growth and $n#estment

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The Growth in eal G'P Per Person

6"

6

26"

26

36"

36

46"

7!"8 79"8 9 "8 93"8 9 "8 9!"8"

G r o w

t h R a

t e ( %

p e r

y e a r )

Chapter 24662

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