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25
PRODUCTION AND
GROWTH
WHAT’S NEW IN THE S
EVENTH
EDITION:
There
is a new
In the News
box on “
Does Food Aid Help
or Hurt?
”
LEARNING
OBJECTIVES:
By the end of
this chapter, students should understand:
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how much
economic growth differs around the world.
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why
productivity is the key determinant of a country’s
standard of living.
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the factors that determine
a country’s productivity.
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how a country’s policies
influence its productivity growth.
CONTEXT AND PURPOSE:
Chapter 12 is the first chapter in a
four-chapter sequence on the production of output
in the long run.
Chapter 12 addresses
the determinants of the level and growth rate of
output. We find that capital and
labor
are among the primary determinants of output. In
Chapter 13, we address how saving and
investment in capital goods affect the
production of output, and in Chapter 14, we learn
about some of
the tools people and
firms use when choosing capital projects in which
to invest. In Chapter 15, we
address
the market for labor.
The
purpose of Chapter 12 is to examine the long-run
determinants of both the level and the growth
rate of real GDP per person. Along the
way, we will discover the factors that determine
the productivity
of workers and address
what governments might do to improve the
productivity of their citizens.
KEY POINTS:
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Economic
prosperity, as measured by GDP per person, varies
substantially around the world. The
average income in the world’s richest
countries is more than ten times that in the
world’s poorest
countries. Because
growth rates of real GDP also vary substantially,
the relative positions of
countries can
change dramatically over time.
209
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duplicated, or posted to a publicly accessible
website, in whole or in part.
210
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Chapter
12/Production and Growth
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Government policies can
try to influence the economy’s growth rate in many
ways:
by
encouraging saving
and investment, encouraging investment from
abroad, fostering education,
promoting
good health, maintaining property rights and
political stability, allowing free trade, and
promoting the research and development
of new technologies.
The accumulation
of capital is subject to diminishing returns: The
more capital an economy has,
the less
additional output the economy gets from an extra
unit of capital. As a result, while
higher saving leads to higher growth
for a period of time, growth eventually slows down
as
capital, productivity, and income
rise. Also because of diminishing returns, the
return to capital is
especially high in
poor countries. Other things equal, these
countries can grow faster because of
the catch-up effect.
Population growth has a variety of
effects on economic growth. On the one hand, more
rapid
population growth may lower
productivity by stretching the supply of natural
resources and by
reducing the amount of
capital available for each worker. On the other
hand, a larger population
may enhance
the rate of technological progress because there
are more scientists and engineers.
The
standard of living in an economy depends on the
economy’s ability to produce goods and
services. Productivity, in turn,
depends on the amounts of physical capital, human
capital, natural
resources, and
technological knowledge available to workers.
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CHAPTER OUTLINE:
I.
Economic Growth around
the World
Table
1
A.
Table 1 shows data on real GDP per
person for 13 countries during different periods
of time.
1.
The
data reveal the fact that living standards vary a
great deal between these countries.
2.
Growth rates are also
reported in the table. Japan has had the largest
growth rate over time,
2.65% per year
(on average).
Use Table 1
to make the point that a one-
percentage
point change in a country’s
growth rate
can make a significant difference over several
generations. The powerful
effects of
compounding should be used to underscore the
process of economic
growth.
3.
Because of different growth rates, the
ranking of countries by income per person changes
over time.
a.
In the late 19th century, the United
Kingdom was the richest country in the world.
b.
Today, income
per person is lower in the United Kingdom than in
the United States (a
former colony of
the United Kingdom).
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2012 Cengage Learning. All
Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapter
12/Production and Growth
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211
B.
FYI: Are
You Richer Than the Richest American?
1.
According to the magazine
American Heritage
, the
richest American of all time is John B.
Rockefeller, whose wealth today would
be the equivalent of approximately $$200 billion.
2.
Yet, because Rockefeller
lived from 1839 to 1937, he did not get the chance
to enjoy many
of the conveniences we
take for granted today such as television, air
conditioning, and
modern medicine.
3.
Thus, because of
tech
nological advances, the average
American today may enjoy a “richer”
life than the richest American who
lived a century ago.
C.
FYI:
A Picture Is Worth a Thousand
Statistics
1.
This box presents three photos showing
a typical family in three countries
–
the United
Kingdom, Mexico, and Mali. Each family
was photographed outside their home, together with
all of their material possessions.
2.
These photos demonstrate
the vast difference in the standards of living in
these countries.
Productivity: Its Role
and Determinants
A.
Why
Productivity Is So Important
1.
Example: Robinson Crusoe
B.
How
Productivity Is Determined
1.
Physical Capital per Worker
a.
Definition of
physical capital: the stock of
equipment and structures used to
produce goods and services
.
b.
Example: Crusoe will
catch more fish if he has more fishing poles.
2.
Human Capital per Worker
a.
Definition of
human capital: the knowledge and skills
that workers acquire
through education,
training, and experience
.
b.
Example: Crusoe will catch more fish if
he has been trained in the best fishing techniques
or as he gains experience fishing.
a.
Because he is stranded
alone, he must catch his own fish, grow his own
vegetables, and
make his own clothes.
b.
His standard of living
depends on his ability to produce goods and
services.
2.
Definition of
productivity: the quantity of goods and
services produced from each
unit of
labor input.
3.
Review of Principle #8: A Country’s
Standard of Living Depends on Its Ability to
Produce
Goods and Services.
II.
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2012 Cengage
Learning. All Rights Reserved. May not be scanned,
copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
212
?
Chapter 12/Production and Growth
b.
Example: Crusoe will have better luck
catching fish if there is a plentiful supply
around
his island.
4.
Technological Knowledge
a.
Definition of
technological
knowledge
: society’s understanding of
the best ways
to produce goods and
services
.
b.
Example: Crusoe will catch more fish if
he has invented a better fishing lure.
C.
FYI: The Production
Function
1.
A
production function describes the relationship
between the quantity of inputs used in
production and the quantity of output
from production.
2.
The
production function generally is written like
this:
3.
Natural Resources
per Worker
a.
Definition of
natural resources: the inputs into
production that are provided by
nature,
such as land, rivers, and mineral
deposits
.
Y
?
A F(L, K, H,
N)
where
Y
= output,
L
= quantity of labor,
K
= quantity of physical
capital,
H
= quantity of
human capital,
N
= quantity of natural resources,
A
reflects the available
production
technology, and
F
() is a
function that shows how inputs are combined to
produce output.
3.
Many
production functions have a property called
constant returns to scale.
a.
This property implies that as all
inputs are doubled, output will exactly double.
b.
This implies that the
following must be true:
xY
?
A F(xL, xK,
xH, xN)
where
x
= 2 if inputs are doubled.
c.
This also means that if
we want to examine output per worker we could set
x
=
1/
L
and
we would
get the following:
Y/L
?
A F(1, K/L,
H/L, N/L)
This shows that
output per worker depends on the amount of
physical capital per worker
(
K
/
L
), the amount
of human capital per worker
(
H
/
L
), and the
amount of natural
resources per worker
(
N
/
L
).
4.
Case Study: Are Natural
Resources a Limit to Growth?
a.
This section
points out that as the population has grown over
time, we have discovered
ways to lower
our use of natural resources. Thus, most
economists are not worried about
shortages of natural resources.
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2012 Cengage Learning. All
Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible
website, in whole or in part.
Chapter
12/Production and Growth
?
213
III.
Economic Growth and Public Policy
Start out by asking students what
factors they believe will lead to greater economic
growth in the future.
B.
Diminishing Returns and
the Catch-Up Effect
1.
Definition of
diminishing
returns: the property whereby the benefit from an
extra
unit of an input declines as the
quantity of the input increases
.
A.
Saving and Investment
1.
Because capital is a
produced factor of production, a society can
change the amount of
capital that it
has.
2.
However, there is an
opportunity cost of doing so; if resources are
used to produce capital
goods, fewer
goods and services are produced for current
consumption.
Figure 1
a.
As the capital stock rises, the extra
output produced from an additional unit of capital
will
fall.
b.
This can be seen in Figure 1, which
shows how the amount of capital per worker
determines the amount of output per
worker, holding constant all other determinants of
output.
c.
Thus, if workers already have a large
amount of capital to work with, giving them an
additional unit of capital will not
increase their productivity by much.
d.
In the long run, a higher
saving rate leads to a higher level of
productivity and income,
but not to
higher growth rates in these variables.
2.
An important implication
of diminishing returns is the catch-up effect.
a.
Definition of
catch-up effect: the property whereby
countries that start off poor
tend to
grow more rapidly than countries that start off
rich
.
b.
When workers
have very little capital to begin with, an
additional unit of capital will
increase their productivity by a great
deal.
C.
Investment from Abroad
2.
Investment in the country by foreigners
can also occur.
a.
Foreign
direct investment occurs when a capital investment
is owned and operated by a
foreign
entity.
1.
Saving by
domestic residents is not the only way for a
country to invest in new capital.
?
2012 Cengage Learning. All
Rights Reserved. May not be scanned, copied or
duplicated, or posted to a publicly accessible
website, in whole or in part.