ECON 1950 - Ch.7 Notes - PRODUCTION AND GROWTH PDF

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Lecture Notes for Economics 1950
Assigned Reading - Chapter 7 Principles of Macroeconomics, 7th Canadian Edition, Mankiw; Kneebone; McKenzie...

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CHAPTER 7 - ECONOMIC GROWTH AROUND THE WORLD:

See Table 7.1 There are great differences in living standards around the world. These differences can be observed by comparing real GDP per person for different countries. Growth rates of real GDP also vary substantially, and as a result, the ranking of countries by income per person changes dramatically over time. à the level of income per person is a good gauge of economic prosperity àthe rate of growth in income per person is a good gauge of economic progress PRODUCTIVITY: the quantity of goods and services produced for each unit of a worker’s time. Y = real GDP = the quantity of output produced L = quantity of labour Productivity = Y/L (output per worker) Why productivity is important -

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The standard of living depends on the ability to produce goods and services. Productivity measures the ability to produce goods and services. As productivity increases, workers can produce more goods and services for each unit of time. As a result, output and income increase. The more a country produces, the more it can consume. When productivity grows rapidly, so do living standards.

Determinants of Productivity (Why are some economies so much better at producing goods and services than others?)

I.

Physical Capital: the stock of equipment and structures that are used to produce goods and services.

II.

Human Capital: the knowledge and skills that workers acquire through education, training, and experience. Health is also a factor in human capital.

III.

Natural Resources: the inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposit. a. Renewable resources b. Non-renewable resources

IV.

Technological Knowledge: society’s understanding of the best ways to produce goods and services

THE PRODUCTION FUNCTION :

A production function describes the relationship between the quantity of inputs used in production and the quantity of output produced. Y = AF (L, K, H, N) Where, Y = output, L = quantity of labour, K = quantity of physical capital, H = quantity of human capital, N = quantity of natural resources, A reflects the available technology, and F is a function that shows how inputs are combined to produced output. Y = AF (L, K, H, N) Technological knowledge (A), reflects the way the inputs are combined in the process of producing goods and services. How can we combine our resources? All firms hire labour (L), rent capital (K), and use other inputs to produce output. The composition of these inputs differs across countries. For example, China uses labour-intensive methods of production, whereas in Canada firms use capital-intensive method of production. Many production functions have a property called constant returns to scale (CRS). This property implies that when all inputs are doubled, output (Y) will also be doubled. Constant Returns to Scale:

xY = AF (xL, xK, xH, xN) where, x, represents any integer.

Setting x = 1/L to provide a measure of output per worker: Y/L = AF (1, K/L, H/L, N/L). This shows a positive correlation between output per worker, physical capital per worker (K/L), the amount of human capital per worker (H/L), the amount of natural resources per worker (N/L), and technology (A). ECONOMIC GROWTH AND PUBLIC POLICY POLICY:: (What can government policy do to raise productivity and living standards?)

I.

SAVING AND INVESTMENT Capital is a factor of production used to produce all kinds of goods and services, including more capital. Society can increase the amount of capital by increasing saving and investment. o Devoting more resources to producing capital requires devoting fewer resources to producing goods and services. o Trade off and opportunity cost: growth arises from capital accumulation and requires society to sacrifice current consumption to enjoy higher consumption in the future. [increase capital investment through temporary decrease in consumption]

II.

DIMINISHING RETURNS AND THE CATCH-UP EFFECT: Diminishing Returns: The property whereby the benefit from an extra unit of an input declines as the quantity of the input increases. Diminishing Returns to Capital:

o As stock capital rises, the extra output produced from the increase in capital gets smaller. o When workers have a large quantity of capital, giving them an additional unit of capital only increases their productivity slightly o Due to diminishing returns, increase in the saving rate leads to higher growth only in the short run. o Higher saving rate allows for the accumulation of capital however the benefits received from the additional capital become smaller over time, growth slows down. The Catch-up Effect: The property whereby countries that start off poor tend to grow more rapidly than countries that start rich. (Marginal incremental increase in capital will be greater for countries that start off poorer) o In poor countries, workers lack even the most rudimentary tools and, as a result, have low productivity. Small amounts of capital investment would substantially raise these workers’ productivity.

III.

INVESTMENT FROM ABROAD Funds for capital investments can also come from outside a country a. Foreign direct investments A capital investment that is owned and operated by a foreign entity. Foreign direct investment takes the form of physical assets. Ex. Bombardier builds a plant to assemble airplanes in Ireland b. Foreign portfolio investments A capital investment that is financed with foreign money but operated by domestic residents. Foreign portfolio investment takes the form of financial assets. Ex. Canadian buys stock in an Irish corporation. GNP: Gross National Product, a measure of a country’s productivity less foreign investments but including incomes of citizens living abroad. GNP = GDP – Foreign Investment + Incomes from citizens living abroad

IV.

EDUCATION Education is an investment in human capital. o Government can increase productivity by promoting education. o Investing in human capital has an opportunity cost. The time spent in school means they must forgo wages they may have earned at work. In less-developed countries, children drop out of school because their labour is needed to help support the family. o Human Capital has positive externalities, where the return to society on an investment in human capital (education) is greater than the return for the individual. BRAIN DRAIN: the emigration of many of the most highly educated workers to rich countries, where these workers can enjoy a higher standard of living. If human capital does have positive externalities, then brain drain makes those people left behind poorer than they otherwise would be.

V.

HEALTH AND NUTRITION Human capital can also refer to the expenditures that lead to a healthier population. o Healthier workers are more productive so, making the right investments in the health of the population is one way for a nation to increase productivity and raise living standards. (causality o Policies that lead to more rapid economic growth would naturally improve health outcomes, which in turn would further promote economic growth.

VI.

PROPERTY RIGHTS AND POLITICAL STABILITY Economic growth can be fostered through the protection of property rights and promoting political stability. o Production in market economies arises from the interactions of millions of individuals and firms which allows the economy’s factors of production to be used as effectively as possible. o Courts serve an important role in a market economy: they enforce property rights. PROPERTY RIGHTS: the ability of people to exercise authority over the resources they own. o In less-developed countries where justice systems don’t work well, governments infringe on property rights as firms are expected to bribe powerful governments. o Corruption impedes the coordinating power of markets and it discourages domestic saving and investment from abroad. o Political Instability reduces the incentive for domestic residents to save, invest, and start new businesses. It also reduces the incentive to foreigners to invest in the country.

VII.

FREE TRADE (comparative advantage) Government policies determine how open a country will be able to trade. o Inward-oriented policies aimed at raising productivity and living standards within a country by avoiding interactions with the rest of the world, prevent that country from being able to gain from trade. Further, such countries would need to produce all the goods required for consumption and it would also have to produce all its own capital goods, rather than importing the best equipment an open market may offer. o Outward-oriented policies that eliminate trade restrictions, allow countries to experience the same kind of economic growth that would occur after a major technological advance. o Trade is also determined by geography. Countries with good natural seaports like, China (Hong Kong), find trade easier than landlocked countries (African Countries), as a result, income levels and GDP per person for countries with easy access to waterways will be higher.

VIII.

RESEARCH AND DEVELOPMENT Knowledge is a public good: Once one person discovers an idea, the idea enters society’s pool of knowledge, and other people can freely use it. o Governments encourage the research and development of new technologies that improve the ability to produce goods and services.

IX.

o Offering tax breaks and awarding patents to inventors of original products enhances the incentive for individuals and firms to engage in research. POPULATION GROWTH The most direct effect of population growth on a society is the size of the labour force. A large population means more workers to produces goods and services, however, a large population means more people to consume those goods and services. As a result, a larger population does not mean a higher standard of living for a typical citizen. A. Stretching Natural Resources: § Thomas Robert Malthus argued that rapid population growth would continually strain society’s ability to provide for itself thereby, lowering productivity by stretching the supply of resources. § Malthus view was correct for time he lived however living standards around the world right now are much higher. § Famines Today are more often the result of an unequal income distribution or political instability. § Malthus did not factor in technological advances that greatly enhance productivity. B. Diluting the Capital Stock: § High population growth means that each worker is equipped with less capital. A decrease in the quantity of capital per worker leads to lower productivity and lower GDP per worker (Y/L) § Policy makers attempt to influence population growth through the implementation of laws that regulate the number of children families may have (China) § People respond to incentives: increasing the opportunity cost of having children will cause people to have smaller families. Governments can introduce policies that foster the equal treatment of women, allowing them the opportunity to receive a good education and desirable employment in less developed economies will help to reduce the rate of population growth. C. Promoting Technological Progress: § The benefit of High population growth is that there are more people with specialized qualifications to contribute to technological advancement, which benefits everyone. § Large population is a prerequisite for technological advance.

A COUNTRY’S STANDARD OF LIVING DEPENDS ON ITS ABILITY TO PRODUCE GOODS AND SERVICES. POLICY MAKERS WHO WANT TO ENCOURAGE GROWTH IN STANDARDS OF LIVING MUST AIM TO INCREASE THEIR NATIONS’ PRODUCTIVE ABILITY BY ENCOURAGING RAPID ACCUMULATION OF THE FACTORS OF PRODUCTION AND ENSURING THAT THESE FACTORS ARE EMPLOYED AS EFFECTIVELY AS POSSIBLE....