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?2007 Thomson South-Western?2007 Thomson South-WesternProduction and GrowthA countrys standard of living depends on its ability to produce goods and services.Within a country there are large changes in the standard of living over time.In the United States over the past century,average income as measured by real GDP per person has grown by about 2 percent per year.Production and GrowthA countryProduction and GrowthProductivityrefers to the amount of goods and services produced from each unit of labor input.A nations standard of living is determined largely by the productivity of its workers.Production and GrowthProductivTable 1 The Variety of Growth Experiences Table 1 The Variety of Growth ECONOMIC GROWTH AROUND THE WORLDLiving standards,as measured by real GDP per person,vary significantly among nations.The poorest countries have average levels of income that have not been seen in the United States for many decades.Annual growth rates that seem small become large when compounded for many years.Compounding refers to the accumulation ECONOMIC GROWTH AROUND THE WORProductivity:Its Role and DeterminantsWhy Productivity Is So Important Productivityplays a key role in determining living standards for all nations in the world.To understand the large differences in living standards across countries,we must focus on the production of goods and services.Productivity:Its Role and DetHow Productivity Is DeterminedThe inputs used to produce goods and services are called the factors of production.The factors of production include:Physical capitalHuman capitalNatural resourcesTechnological knowledgeThe factors of production directly How Productivity Is DeterminedHow Productivity Is DeterminedPhysical capitalper worker is the stock of equipment and structures that are used to produce goods and services.Physical capital includes:Tools used to build or repair automobiles.Tools used to build furniture.Office buildings,schools,etc.Physical capital is a produced factor of production.It is an input into the production process that in the past was an output from the production process.How Productivity Is DeterminedHow Productivity Is DeterminedHuman capitalper worker is the economist s term for the knowledge and skills that workers acquire through education,training,and experience.Like physical capital,human capital raises a nation s ability to produce goods and services.How Productivity Is DeterminedHow Productivity Is DeterminedNatural resources are inputs used in production that are provided by nature,such as land,rivers,and mineral deposits.Renewable resources include trees and forests.Nonrenewable resources include petroleum and coal.Natural resources can be important but are not necessary for an economy to be highly productive in producing goods and How Productivity Is DeterminedHow Productivity Is DeterminedTechnological knowledge includes society s understanding of the best ways to produce goods and services.Human capital includes the resources expended transmitting this understanding to the labor force.How Productivity Is DeterminedFYI:The Production FunctionEconomists often use a production function to describe the relationship between the quantity of inputs used in production and the quantity of output from production.FYI:The Production FunctionEcFYI:The Production FunctionY=A F(L,K,H,N)Y=quantity of outputA=available production technologyL=quantity of laborK=quantity of physical capitalH=quantity of human capitalN=quantity of natural resourcesF()is a function that shows how the inputs are combined.FYI:The Production FunctionY=FYI:The Production FunctionA production function has constant returns to scale if,for any positive number x,xY=A F(xL,xK,xH,xN)That is,a doubling of all inputs causes the amount of output to double as well.FYI:The Production FunctionA FYI:The Production FunctionProduction functions with constant returns to scale have an interesting implication.Setting x=1/L,Y/L=A F(1,K/L,H/L,N/L)Where:Y/L=output per workerK/L=physical capital per workerH/L=human capital per workerN/L=natural resources per workerFYI:The Production FunctionPrFYI:The Production FunctionThe preceding equation says that productivity(Y/L)depends on:physical capital per worker(K/L),human capital per worker(H/L),and natural resources per worker(N/L),as well as the state of technology(A).FYI:The Production FunctionThECONOMIC GROWTH AND PUBLIC POLICY Government policies that raise productivity and living standardsEncourage saving and investment.Encourage investment from abroad.Encourage education and training.Establish secure property rights and maintain political stability.Promote free trade.Promote research and development.ECONOMIC GROWTH AND PUBLIC POLSaving and Investment One way to raise future productivity is to invest more current resources in the production of capital.Saving and Investment One way Diminishing Returns and the Catch-Up EffectAs the stock of capital rises,the extra output produced from an additional unit of capital falls;this property is called diminishing returns.Because of diminishing returns,an increase in the saving rate leads to higher growth only for a while.In the long run,the higher saving rate leads to a higher level of productivity and Diminishing Returns and the CaIllustrating the Production FunctionOutputper worker11Capital perworker1.When the economy has a low level of capital,anextra unit of capital leads to a large increase in output.2.When the economy has ahigh level of capital,anextra unit of capital leads toa small increase in output.Illustrating the Production FuDiminishing Returns and the Catch-Up EffectThe catch-up effect refers to the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich.Diminishing Returns and the CaInvestment from AbroadGovernments can increase capital accumulation and long-term economic growth by encouraging investment from foreign sources.Investment from abroad takes several forms:Foreign Direct InvestmentCapital investment owned and operated by a foreign entity.Foreign Portfolio InvestmentInvestment from AbroadGovernmeEducationFor a country s long-run growth,education is at least as important as investment in physical capital.In the United States,each year of schooling raises a persons wage,on average,by about 10 percent.Thus,one way the government can enhance the standard of living is to provide schools and encourage the population to take advantage of them.EducationFor a countrys long-EducationAn educated person might generate new ideas about how best to produce goods and services,which in turn,might enter society s pool of knowledge and provide an external benefit to others.One problem facing some poor countries is the brain drain the emigration of many of the most highly educated workers to rich countries.EducationAn educated person miHealthier workers are more productive.Good investments in the health of the population can lead to increase living standards.Countries can get caught in a vicious cycle.Health and NutritionPeople cannot afford adequate health care and nutritious food.People are poorHealthier workers are more proProperty Rights and Political StabilityProperty rights refer to the ability of people to exercise authority over the resources they own.An economy-wide respect for property rights is an important prerequisite for the price system to work.It is necessary for investors to feel that their investments are secure.Property Rights and Political Free TradeTrade is,in some ways,a type of technology.A country that eliminates trade restrictions will experience the same kind of economic growth that would occur after a major technological advance.Free TradeTrade is,in some waFree TradeSome countries engage in.inward-orientated trade policies,avoiding interaction with other countries.outward-orientated trade policies,encouraging interaction with other countries.Free TradeSome countries engagResearch and DevelopmentThe advance of technological knowledge has led to higher standards of living.Most technological advance comes from private research by firms and individual inventors.Government can encourage the development of new technologies through research grants,tax breaks,and the patent system.Research and DevelopmentThe adPopulation GrowthEconomists and other social scientists have long debated how population growth affects a society.Population growth interacts with other factors of production:Stretching natural resourcesDiluting the capital stockPromoting technological progressPopulation GrowthEconomists anEconomic prosperity,as measured by real GDP per person,varies substantially around the world.The average income of the worlds richest countries is more than ten times that in the worlds poorest countries.The standard of living in an economy depends on the economys ability to produce goods and services.Economic prosperity,as measurProductivity depends on the amounts of physical capital,human capital,natural resources,and technological knowledge available to workers.Government policies can influence the economys growth rate in many different ways.Productivity depends on the amThe accumulation of capital is subject to diminishing returns.Because of diminishing returns,higher saving leads to a higher growth for a period of time,but growth will eventually slow down.Also because of diminishing returns,the return to capital is especially high in poor countries.The accumulation of capital is
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