Macro Chapter 12 Production and Growth PDF

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Notes for Macro with Rafia Zafar...

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Production and Growth Economic Growth ○ ○ ○ ○

Recall from the circular flow diagram that income = expenditures = GDP Total expenditure is an expenditure on output: goods and services produced Therefore only when you are producing a lot of stuff you will have a high income We will focus on long-run determinants of the level and growth of the real GDP

Differences between Countries ○ Recall principle 8: A country’s standard of living depends on its ability to produce goods and services ○ The level of Real GDP is a good measurement of economic prosperity and the growth of real GDP is a good measurement of economic progress ○ Facts ■ Real GDP per person vary widely from country to country ■ Growth of Real GDP is how rapidly real GDP per person grew in a typical year ■ Because of differences in growth rates, ranking of countries by income changes substantially over time

Productivity ○ The quantity of goods and services produced from each unit of labor input ○ Why is productivity so important? ■ Productivity is a key determinant of living standards ■ Growth in productivity is the key determinant of growth in living standard ■ A nation can enjoy a high standard of living only if it can produce a large quantity of goods and services ■ An economy’s income is the economy’s output

Determinants of Productivity ○ Physical Capital–Stock of equipment and structures used to produce goods and services ■ Y=F(C,L) Minimum Capital (C) and Labor (L) to produce something ○ Human Capital–The knowledge and skills that workers acquire through education, training, and experience ○ Natural Resources–The inputs the production of goods and services that are provided by nature such as land, rivers, and mineral deposits ■ Not every country that has good natural resources will have a high growth rate or high GDP ○ Technological Knowledge–Society’s understanding of the best way to produce goods and services ■ Most efficient way (ex. Assembly line)

Growth and Productivity in the Limit ○ Some argue that the availability of natural resources (food, energy, etc.) will at some point limit growth and production capabilities. ○ We can change the level of production achievable (the limit) with new technologies (limit on technology, hinders production) ○ Perhaps a limit does exist, but that would have to include a limit to technological progress.

Economic Growth and Public Policy ○ The million dollar questions: ■ What factors will lead to greater economic growth in the future? ● Education (professional degrees), limit outsourcing, innovations in technology, STEM (90% of stem workers in US are immigrants), services (healthcare), reverse globalization, ■ How can government policy raise productivity and living standards ● Invest in specific or targeted areas (healthcare ex)

Saving and Investment ○ One way to increase future productivity is to invest more current resources in the production of capital ○ For society to invest more in capital, it must consume less and save more of its current income (opportunity cost) ○ Therefore, if you increase saving and investment you can produce more tomorrow but only at the expense of less consumption today (trade off) ○ How does higher saving rates increase GDP?

■ Higher saving rates means that fewer resources are used to make consumption goods ■ The resources that are saved are used to make capital goods ■ Capital stock increases ■ Increase in capital stock causes an increase in productivity ■ More rapid growth in GDP

Diminishing Returns ○ The property whereby the benefits from an extra unit of an input declines as the quantity of the input increases ○ As the capital stock rises, the extra output produced from an additional unit of capital will fall ○ In the long run, the higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables ○ An important implication of diminishing returns is the catch-up effect

○ Catch-Up Effect: the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich. When workers have very little capital to begin with, an additional unit of capital will increase their productivity by a great deal. ■ Rich countries- High productivity, additional capital investment will have a small effect on productivity ■ Poor countries- Low productivity, even a small amount of capital investment will increase workers productivity substantially.

Investment from Abroad ○ Another way for a country to invest in new capital ○ Foreign Direct Investment- Capital investment that is owned and operated by a foreign entity (increase GDP directly because it is located in your country)

○ Foreign Portfolio Investment- Investment financed with foreign money by operated by domestic residents (increases GDP as well (production in country)) ○ The benefits from foreign investment: ■ Some of the benefits flow back to the foreign capital owners ■ The investment increases the stock capital in the country ■ Increases productivity and wages ■ Also, investment from abroad is one way for poor countries to learn the advanced technology developed and used in richer countries ○ The World Bank and the IMF ■ Set up after WWII because of the understanding that economic distress leads to: Political turmoil, international tensions, and military conflict ■ Organizations that encourage flow of capital to poor countries ■ Make loans to less developed countries (roads, sewer systems, schools, other types of capital) ■ Give advice about how the funds might best be used

Education ○ Investment in human capital is at least as important as investment in physical capital for a country’s long-run economic success ○ Because there are positive externalities in education, the effect of lower education on the economic growth rate of country can be large ■ Positive externalities: skilled labor force, more informed citizens, better voters, keep town clean, ○ Investment in human capital also has an opportunity cost. In less-developed countries, this opportunity cost is considered to be high; as a result, children often drop out of school at a young age. ■ The opportunity cost is the money, time that would have been spent working,

Health and Nutrition ○ Human capital can also be used to describe another type of investment in people: expenditures that lead to a healthier population ○ Other things being equal, healthier workers are more productive ○ Robert Fogel (Nobel 1993 for economic history) found that improved nutrition accounted for about 30% of growth in per capita income in the UK from 1790 to 1980. ○ A vicious circle: poor nations have poor health, which detracts from productivity and the low productivity contributed to low income which leads to bad health care systems ■ In order to break the cycle you need outside help (other countries, World

Bank, IMF etc)

Property Rights and Political Stability ○ An important prerequisite for the price system to work is an economy wide respect to property rights ○ There is little incentive to produce products if there is no guarantee that they cannot be taken. Contracts must also be enforced ○ Countries with questionable enforcement of property rights or an unstable political climate will also have foreign (or even domestic) investment

Free Trade ○ Trade allows a country to specialize in what it does best and thus consume beyond its production possibilities ○ Free trade will lead to the same kind of economic growth that would occur after a major technological development ○ The amount a nation trades is determined not only by government policy but also by geography (countries with good, natural seaports find trade easier than countries without this resource). ○ Benefits of importing goods ■ Specialization: Increase Productivity ■ Variety of goods ■ Lowers Cost of Production

Research and Development ○ The primary reason why living standards have improved over time had been due to large increases in technological knowledge (knowledge as public good) ○ The US government promotes the creation of new technological information by providing research grants and providing tax incentives for firms engaged in research ○ The patent system also encourages research by granting an inventor the exclusive right to produce the product for a specified number of years

Population Growth ○ A large population can encourage research and produce more goods and services ○ On the other hand, large population reduces GDP per worker because it forces the capital stock to be spread more thinly ○ Countries have aging problem (too many dependents) ○ Want Less Dependents and High Adult/Young Work Force...