Production and Growth

Production and Growth

 There is tremendous variation in the standard of living
around the world.
 The average income in rich country is more than ten
times the average income in a poor country.
(US/Nigeria)
 Even 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.
 Although 2 % might seem small, this rate of growth
implies that average income doubles every 35 years.
 The mathematical approximation called the rule of 70
provides a quantitative grasp of the effect of economic
growth. It tells us that we can find the no. of years it will
take for some measure to double, given its annual
percentage increase, by dividing that percentage
increase into the no. 70.
Approximate no. of years
required to double real GDP = 70 / annual percentage rate of growth
 Annual 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.
 Suppose China and Italy have identical GDPs, but China
grows at 8 % yearly rate, while Italy grows at 2 %.
 China’s GDP would double in about 9 years
(70/8=8.75), while Italy’s GDP would double in 35 years
(70/2=35).
 So a question arises
 What explains these diverse experiences?

 How can the rich countries be sure to maintain their

high standard of living?
 What policies should the poor countries pursue to
promote more rapid growth and join the developed
world?
 These are among the most imp. questions in
macroeconomics.
Economic Growth Around The World
 Economists define and measure economic growth as
 An increase in real GDP occurring over some time period
 An increase in real GDP per capita occurring over some time
period
 As we know, that the level of real GDP is a good gauge
of economic prosperity and the growth of real GDP is a
good gauge of economic progress.
 So, we focus on the long run determinants of the level
and growth of real GDP.
 For the study of long run growth, let’s look at the
experiences of some of the world’s economies.
The Variety of Growth Experiences

The growth rate measures how rapidly real GDP per person grew in the typical year. E.g., in US,
If real GDP per person, beginning at $3347 were to increase by 1.81% for each of 130 years,
it would end up at $ 34,260. However, some years it rose by more and other years by less.
Economic Growth Around The World
 Living 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.
PRODUCTIVITY: ITS ROLE AND
DETERMINANTS
 Productivity plays a key role in determining living
standards for all nations in the world.
Why Productivity Is So Important

 Productivity refers to the amount of goods and services

that a worker can produce from each hour of work.
 A nation’s standard of living is determined by the
productivity of its workers.
 To understand the large differences in living standards
across countries, we must focus on the production of
goods and services.
How Productivity Is Determined

 The inputs used to produce goods and services are

called the factors of production.
 The factors of production directly determine productivity.
 The Factors of Production
 Physical capital
 Human capital
 Natural resources
 Technological knowledge
How Productivity Is Determined

 Physical Capital
 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.

 a produced factor of production.

 It is an input into the production process that in the past was an

output from the production process.

• The woodworker uses a lathe to make a leg of the table.
Earlier, the lathe itself was the output of a firm that
manufactures lathes.
How Productivity Is Determined

 Human Capital
 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.
 A produced factor of production
 Producing human capital requires inputs in the form of
teachers, libraries and student time.
How Productivity Is Determined

 Natural Resources
 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.
 can be important but are not necessary for an
economy to be highly productive in producing goods
and services. (Japan … few natural resources)
How Productivity Is Determined

 Technological Knowledge
 society’s understanding of the best ways to produce
goods and services.
 Technological Knowledge refers to society’s
understanding about how the world works.
 Human capital refers to the resources expended
transmitting this understanding to the labor force.
 Knowledge is quality of society’s textbooks, whereas
HC is the amount of time that the population has
devoted to reading them.
The Production Function

 Economists often use a production function to

describe the relationship between the quantity of
inputs used in production and the quantity of
output from production.
The Production Function
 Y = A F(L, K, H, N)
 Y = quantity of output
 A = a variable that reflects available production technology ( As
technology improves, A rises, so economy produces more output
from any given combination of inputs.
 L = quantity of labor
 K = quantity of physical capital
 H = quantity of human capital
 N = quantity of natural resources
 F( ) is a function that shows how the inputs are combined.
The Production Function
 A 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.
 In some industries, a rather wide range of output may
exist between the output at which economies of scale
end and the output at which diseconomies of scale
begin. That is , there may be range of constant returns
to scale over which long-run average cost does not
change.
The Production Function
 Production 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 worker (measure of productivity)
K/L = physical capital per worker
H/L = human capital per worker
N/L = natural resources per worker
The Production Function
 The 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).