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9 THE REAL ECONOMY IN THE LONG RUNCopyright 2004 South-Western25Production and Growth Copyright 2004 South-WesternProduction and GrowthA countrys standard of living depends on its ability to produce goods and services.Copyright 2004 South-WesternProduction and GrowthWithin a country there are large changes in the standard of living over time.Copyright 2004 South-WesternProduction and GrowthIn the United States over the past century,average income as measured by real GDP per person has grown by about 2 percent per year.Copyright 2004 South-WesternProduction and GrowthProductivity refers to the amount of goods and services produced for each hour of a workers time.A nations standard of living is determined by the productivity of its workers.Table 1 The Variety of Growth ExperiencesCopyright2004 South-WesternCopyright 2004 South-WesternECONOMIC GROWTH AROUND THE WORLDLiving standards,as measured by real GDP per person,vary significantly among nations.Copyright 2004 South-WesternECONOMIC GROWTH AROUND THE WORLDThe poorest countries have average levels of income that have not been seen in the United States for many decades.Copyright 2004 South-WesternECONOMIC GROWTH AROUND THE WORLDAnnual growth rates that seem small become large when compounded for many years.Compounding refers to the accumulation of a growth rate over a period of time.Copyright 2004 South-WesternPRODUCTIVITY:ITS ROLE AND DETERMINANTSProductivity plays a key role in determining living standards for all nations in the world.Copyright 2004 South-WesternWhy Productivity Is So ImportantProductivity refers to the amount of goods and services that a worker can produce from each hour of work.Copyright 2004 South-WesternWhy Productivity Is So ImportantTo understand the large differences in living standards across countries,we must focus on the production of goods and services.Copyright 2004 South-WesternHow Productivity Is DeterminedThe inputs used to produce goods and services are called the factors of production.The factors of production directly determine productivity.Copyright 2004 South-WesternHow Productivity Is DeterminedThe Factors of ProductionPhysical capitalHuman capitalNatural resourcesTechnological knowledgeCopyright 2004 South-WesternHow Productivity Is DeterminedPhysical Capitalis a produced factor of production.It is an input into the production process that in the past was an output from the production process.is the stock of equipment and structures that are used to produce goods and services.Tools used to build or repair automobiles.Tools used to build furniture.Office buildings,schools,etc.Copyright 2004 South-WesternHow Productivity Is DeterminedHuman Capitalthe economists term for the knowledge and skills that workers acquire through education,training,and experience Like physical capital,human capital raises a nations ability to produce goods and services.Copyright 2004 South-WesternHow Productivity Is DeterminedNatural Resourcesinputs 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.can be important but are not necessary for an economy to be highly productive in producing goods and services.Copyright 2004 South-WesternHow Productivity Is DeterminedTechnological Knowledgesocietys understanding of the best ways to produce goods and services.Human capital refers to the resources expended transmitting this understanding to the labor force.Copyright 2004 South-WesternFYI: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.Copyright 2004 South-WesternFYI: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.Copyright 2004 South-WesternFYI: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.Copyright 2004 South-WesternFYI: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)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 workerCopyright 2004 South-WesternFYI: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).Copyright 2004 South-WesternECONOMIC GROWTH AND PUBLIC POLICYGovernments can do many things to raise productivity and living standards.Copyright 2004 South-WesternECONOMIC GROWTH AND PUBLIC POLICY Government Policies That Raise Productivity and Living StandardsEncourage saving and investment.Encourage investment from abroadEncourage education and training.Establish secure property rights and maintain political stability.Promote free trade.Promote research and development.Copyright 2004 South-WesternThe Importance of Saving and Investment One way to raise future productivity is to invest more current resources in the production of capital.Figure 1 Growth and InvestmentCopyright2003 Southwestern/Thomson Learning(a)Growth Rate 19601991(b)Investment 19601991South KoreaSingaporeJapanIsraelCanadaBrazilWest GermanyMexicoUnited KingdomNigeriaUnited StatesIndiaBangladeshChileRwandaSouth KoreaSingaporeJapanIsraelCanadaBrazilWest GermanyMexicoUnited KingdomNigeriaUnited StatesIndiaBangladeshChileRwandaInvestment(percent of GDP)Growth Rate(percent)01234567010203040Copyright 2004 South-WesternDiminishing 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.Copyright 2004 South-WesternDiminishing Returns and the Catch-Up EffectIn the long run,the higher saving rate leads to a higher level of productivity and income,but not to higher growth in these areas.Copyright 2004 South-WesternDiminishing 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.Copyright 2004 South-WesternInvestment from AbroadGovernments can increase capital accumulation and long-term economic growth by encouraging investment from foreign sources.Copyright 2004 South-WesternInvestment from AbroadInvestment from abroad takes several forms:Foreign Direct InvestmentCapital investment owned and operated by a foreign entity.Foreign Portfolio InvestmentInvestments financed with foreign money but operated by domestic residents.Copyright 2004 South-WesternEducationFor a countrys 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.Copyright 2004 South-WesternEducationAn educated person might generate new ideas about how best to produce goods and services,which in turn,might enter societys pool of knowledge and provide an external benefit to others.Copyright 2004 South-WesternEducationOne problem facing some poor countries is the brain drainthe emigration of many of the most highly educated workers to rich countries.Copyright 2004 South-WesternProperty 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.Copyright 2004 South-WesternFree 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.Copyright 2004 South-WesternFree TradeSome countries engage in.inward-orientated trade policies,avoiding interaction with other countries.outward-orientated trade policies,encouraging interaction with other countries.Copyright 2004 South-WesternResearch 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.Copyright 2004 South-WesternCASE STUDY:The Productivity Slowdown and SpeedupFrom 1959 to 1973 productivity grew at a rate of 3.2 percent per year.From 1973 to 1995 productivity grew by only 1.5 percent per year.Productivity accelerated again in 1995,growing by 2.6 percent per year on average during the next six years.Copyright 2004 South-WesternCASE STUDY:The Productivity Slowdown and SpeedupThe causes of the changes in productivity growth are elusive.The slowdown cannot be traced to the factors of production that are most easily measured.Many economists attribute the slowdown and speedup in economic growth to changes in technology and the creation of new ideas.Figure 2 The Growth in Real GDP Per PersonCopyright2003 Southwestern/Thomson LearningGrowth Rate(percentper year)1.01.52.02.53.03.54.0187018901890191019101930193019501950197019701990199020000Copyright 2004 South-WesternPopulation GrowthEconomists and other social scientists have long debated how population growth affects a societyCopyright 2004 South-WesternPopulation GrowthPopulation growth interacts with other factors of production:Stretching natural resourcesDiluting the capital stockPromoting technological progressCopyright 2004 South-WesternSummaryEconomic 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.Copyright 2004 South-WesternSummaryProductivity 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.Copyright 2004 South-WesternSummaryThe 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.
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