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Chapter 25
Production and Growth
Economic Growth around the World
Productivity and Its Determinants
Productivity
• Definition :
– The quantity of goods and services produced from
each unit of labour input.
OR
– Productivity refers to the quantity of goods and
services that a worker can produce from each
hour of work
Misconception about productivity
• Productivity is not about what you produce
but about how efficiently you produce it.
• Take a small country like Switzerland with a
population of 7 million and real GDP per
capita is second in rank after US.
Misconception about productivity
- It has no military power, no car industry, no
computer industry: among many other things, it
exports milk, chocolate, drugs, watches and has
large tourism and banking sectors
- Swiss are rich because they produce goods
and services with very high productivity
Determinants of Productivity
The four determinants of productivity are:
(1) physical capital:
is the stock of machinery, equipment and structures that are
used to produce goods and services, such as
– The machinery in oil refineries, steel mills, power plants
– Tools used to repair automobiles or to build homes
– Office buildings, schools, TV towers, etc.
Determinants of Productivity
• (2) human capital, is the term used by economists to define the
knowledge and skills that working persons in an economy acquire
through education, training and experience
• Education constitutes the most important element in human capital
• Longer and better education of the citizens increase their ability to
undertake complex tasks required in the production process
• Training usually takes place during working life and in firms
• Like physical capital, human capital raises a nation’s capacity to
produce goods and services
Determinants of Productivity
(3) natural resources are inputs used in production that are
provided by nature, such as agricultural land, rivers, mineral
deposits, forests, etc.
• Natural resources can be divided into two major categories
– Renewable: trees, forests, hydroenergy
– Nonrenewable: petroleum, coal, other minerals
• Having a large natural resource can be an advantage but it does not
lead automatically to high productivity
• Some rich countries are poor in natural resources (Denmark, Japan,
Singapore) while some poor countries are rich in natural resources
(Brazil ($11.000 GDP per capita, Iraq($4500 GDP per capita))
Determinants of Productivity
• (4) technological knowledge, Technological knowledge is the
understanding of the best ways to produce goods and services
• Technological knowledge is related to but different from basic science
• A country may be well advanced in basic science and produce many hightech products but still have low real GDP per head (Soviet Union and India
are good examples)
• Producing good wine (France), expensive shoes (Italy), quality cars
(Germany) also correspond to advanced technological knowledge
• Human capital refers to the resources expended to transmit the
technology to the labour force
The Production Function
• Y = A f(L, K, H, N)
• xY= A f(xL, xK, xH, xN)
• If x=2, then 2Y = A f(2L,2K,2H,2N)
• If x = 1/L, then Y/L = A f(1, K/L, H/L, N/L)
Y = A f(L, K, H, N)
• Relationship between the quantity of inputs
used in production
• A is available production technology. As
technology improves A rises, so economy
produce more output from any given
combination of inputs.
Y = A f(L, K, H, N)
• Y denotes the quantity of output,
• L denotes the quantity of labour
• K denotes the quantity of physical capital
(capital)
• H denotes the quantity of human capital
• N denotes the quantity of natural resources.
xY= A f(xL, xK, xH, xN)
• Constant Returns to scale.
• If we double all inputs, it causes the amount
of output to double as well.
• So if write the equation when x=2
• It becomes : 2Y = A f(2L,2K,2H,2N)
x = 1/L, Useful Implication
• Production funciton becomes:
- Y/L = A f( 1, K/L, H/L, N/L)
Y/L is output per worker (measure of productivity)
K/L is capital per worker
H/L is human capital per worker
N/L is natural resources per worker
Productivity or Output per worker
(Y/L)
• Labour Productivity Or Output Per Worker
depends on,
• Available Production Technology,
• Capital per worker,
• Human capital per worker,
• Natural resources per worker,
Natural Resources’ Effect on
Productivity
• Can productivity-driven economic growth
continue indefinitely, given that natural
resources are limited?
• When these shortages start to occur, won’t
they stop economic growth and, perhaps,
even force living standards to fall?
Natural Resources’ Effect on
Productivity
• Technological knowledge makes production
more resource- efficient
• Adjusted price of natural resources tended
remain stable or in some cases even fall over
long period of time
• This shows us while supplies may be falling,
demands are declining even more rapidly.
Economic Growth Public Policy
• What can government policies do to increase
productivity or raise of standard of living?
-By adopting larger,
- Capital per person
- Human Capital per person
- Technological Knowledge
Saving and Investment
• In order to have larger stock of capital,
– Save and Invest more today
– Or Consume less today
We will discuss this issue in chapter 26.
Diminishing Returns to Capital
Catch – Up Effect
• Poorer countries have more to gain than
richer countries.
• Poor countries tend to grow more rapidly than
rich ones.
• This catch-up effect seems to have been
important in fast-growing East Asian
economies.
Investment from Abroad
• Foreign Direct Investment (FDI)
• Foreign Portfolio Investment (FPI)
• The World Bank (WB) raises funds in advanced
countries and uses those funds to make loans
in developing countries.
Education
• Human Capital accumulation raises
productivity through education.
• Human capital has a cost.
• Many economist believe that human capital is
more important than physical capital. Why?
Health and Nutrition
• Human Capital is also related to health of
workers.
• Improved nutrition will lead to growth in GDP.
But How?
Property Rights and Political Stability
• A mining company will not make the effort to
mine iron ore if it expects the ore to be stolen.
• Political Instability hurts property rights and
productivity.
Research and Development
• knowledge is a public good: That is, once one
person discovers an idea, the idea enters
society’s pool of knowledge
• The U.S. government has long played a role in
the creation. This helps to be very improved
on rocket and plane industry.
Population Growth
• Population growth can decrease productivity by:
1. Diluting the stock of physical and human capital
2. Stretching natural resources too thin.
On the other hand, increases in population may
take technological progress more rapid, since there
are more people around to discover and invent.
Summary
• Growth rates of real GDP also vary substantially.
• Productivity, depends on the physical capital, human
capital, natural resources, and technological
knowledge available to workers.
• Government policies can try to influence the
economy’s growth rate in many ways: by
encouraging saving and investment, fostering
education, promoting R&D etc.
Summary
• The accumulation of capital is subject to
diminishing returns.
• Population growth has a variety of effects on
economic growth.
Questions
1. )International data show a positive correlation
between income per person and the health of
the population.
a. Explain how higher income might cause better
health outcomes.
b.Explain how better health outcomes might
cause higher income.
c. How might the relative importance of your
two hypotheses be relevant for public policy?
Questions
2.) International data show a positive correlation
between political stability and economic growth.
a. Through what mechanism could political
stability lead to strong economic growth?
b. Through what mechanism could strong
economic growth lead to political stability?
Questions
3.) In many developing nations, young women
have lower enrollment rates in secondary school
than do young men. Describe several ways in
which greater educational opportunities for
young women could lead to faster economic
growth in these countries.
Questions
4.) How does the rate of population growth
influence the level of GDP per person?