Chapter 25 about Production and Growth.pptx

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1. Chapter 25: Production and Growth 1

2. Look for the answers to these questions: What are the facts about living standards and growth rates around the world? Why does productivity matter for living standards? What determines productivity and its growth rate? How can public policy affect growth and living standards? 2

3. S teps to answer these questions: First, we examine international data on real GDP per person. These data will give you some sense of how much the level and growth of living standards vary around the world. A nation’s standard of living is determined by the productivity of its workers. Hence, we examine the role of productivity—the amount of goods and services produced for each hour of a worker’s time, that is, how many goods and services a worker can produce in an hour. W e analyze the factors that determine a nation’s productivity. W e consider the link between productivity and the policies that governments pursue to raise productivity and living standards. 3

4. How to Calculate Nominal and Real GDP 4

5. A Picture Is Worth a Thousand Statistics A typical family with all their possessions in the U.K., an advanced economy. 5 GDP per capita = $43,269 Child mortality rate = 0.4 %** Access to modern sanitation facilities = 100% Educational attainment =60% enrolled in higher education

6. A Picture Is Worth a Thousand Statistics A typical family with all their possessions in Mexico, a middle income country 6 GDP per capita = $18,258 Child mortality rate = 1.3% Access to modern sanitation facilities = 85% Educational attainment =30%

7. A Picture Is Worth a Thousand Statistics A typical family with all their possessions in Mali, a poor country 7 GDP per capita = $ 1,510 Child mortality rate = 11.5% Access to modern sanitation facilities = 25 % Educational attainment =7%

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9. Economic Growth around the World Because of differences in growth rates Ranking of countries by income changes substantially over time Poor countries are not necessarily doomed to poverty forever, e.g. Singapore incomes were low in 1960 and are quite high now Rich countries can’t take their status for granted : They may be overtaken by poorer but faster-growing countries 9

10. Economic Growth around the World Questions: Why are some countries richer than others? Why do some countries grow quickly while others seem stuck in a poverty trap? What policies may help raise growth rates and long-run living standards? 10

11. Standard of Living and Productivity What is Standard of Living? Standard of living refers to the level of wealth, comfort, material goods, and necessities available to a certain socioeconomic class or geographic area . Link between standard of living and productivity ->To understand large differences in living standards across countries or over time, focus on real GDP, that is, production of goods and services in real terms. Higher productivity-> higher output -> higher income-> higher standard of living Why are some countries so much better at producing goods and services than others? 11

12. Productivity A country’s standard of living depends on its ability to produce goods and services Productivity Quantity of goods and services Produced from each unit of labor input Productivity = Y/L (output per worker), where Y = real GDP = quantity of output produced L = quantity of labor 12

13. Robinson Crusoe by Daniel Defoe Robinson Crusoe wants to travel in his life using a ship. His father, on the other hand, is interested in Crusoe becoming a middle-class law guy. He defies his father’s authority and decided to leave for an adventure on the sea on his own. He sets off and sails for some time. During this period he makes some money from the trade. After some time he is captured and turned into a slave in Africa’s coast. He meets a man by the name Xury , and together they escape from their captors. Crusoe gets lucky to be accepted by a Portuguese captain, and he manages to make it into Brazil. He does well there and manages to buy a plantation of sugar. Soon he gets involved in the slave trade where they would procure slaves taken from Africa. On the journey, the ship gets wrecked, and Crusoe becomes the only one who survives. He makes it to an island that was deserted. His time alone on this island is also productive. He manages to build a shelter for himself. He goes on to build a country home on the opposite side of this island. Also, he constructs a fort containing ammo and guns. Crusoe plants Barleycorn and rice. He even teaches himself bread-making. Crusoe builds furniture, baskets, and some pottery with his time. He also raises goats and has a family of animals consisting of cats dogs and even a parrot which he recovered from the ship. One day, Crusoe discovers a footprint on his shore and realizes that he was not alone. There were cannibals on the islands. He rescues a young native from them and names him Friday. He teaches him English and even makes him a Christian. Crusoe and Friday rescue Friday’s father and a Spaniard from other cannibals. Sometime later, an English boat filled with sailors arrives at the shore. Crusoe discovers that the sailors were planning a mutiny against the ship’s captain and helps restore the ranks and order to this ship. The captain agrees to take Crusoe home. Crusoe makes it back to Europe in the company on Friday. His plantations had made much money. Crusoe gets married and in his late years visits the island. The novel ends. 13

14. Productivity Why productivity is so important Key determinant of living standards When a nation’s workers are very productive, real GDP is large and incomes are high Growth in productivity is the key determinant of growth in living standards When productivity grows rapidly, so do living standards An economy’s income is the economy’s output. Higher productivity-> higher output -> higher income-> higher standard of living 14

15. Determinants of Productivity Physical capital, K Stock of equipment and structures used to produce goods and services Physical capital per worker, K/L Productivity is higher when the average worker has more capital (machines, equipment, etc.). An increase in K/L causes an increase in Y/L Y/L is output per worker, which is a measure of productivity. K/L is the amount of physical capital per worker. 15

16. Determinants of Productivity Human capital, H Knowledge and skills workers acquire through education, training, and experience Human capital per worker, H/L Productivity is higher when the average worker has more human capital (education, skills, etc.). An increase in H/L causes an increase in Y/L. 16

17. Determinants of Productivity Natural resources, N Inputs into production that nature provides (land, rivers, and mineral deposits) Natural resources per worker, N/L Other things equal, more N allows a country to produce more Y An increase in N/L causes an increase in Y/L 17

18. Determinants of Productivity Technological knowledge Society’s understanding of the best ways to produce goods and services Technological progress means: A faster computer, a higher-definition TV, or a smaller cell phone Also, any advance in knowledge that boosts productivity: allows society to get more output from its resources e.g., Henry Ford and the assembly line. 18

19. 19 In 1913, Henry Ford Introduced the Assembly Line: His Workers Hated It. Henry Ford and Assemby -Line Production Ford’s real innovation was the moving assembly line. It didn’t just usher in the age of the car; it changed work forever . Before 1913, Ford and many other car makers put together entire cars at one station. A team of workers labored on each car,  writes  Tony Swan for  Car and Driver . The innovation of the moving assembly line cut the number of workers required and reduced the time it took to assemble a car. It also gave the company more control over the pace of production.

20. Determinants of Productivity Technological knowledge vs. Human capital Technological knowledge Refers to society’s understanding of the best ways (cost effective, requiring less resources per unit of output) to produce goods and services Human capital Results from the effort people expend to acquire this knowledge Both are important for productivity 20

21. ASK THE EXPERTS 21 Innovation and Growth “Future innovations worldwide will not be transformational enough to promote sustained per-capita economic growth rates in the United States and western Europe over the next century as high as those over the past 150 years.”

22. The Production Function The production function Y = A F(L, K, H, N) A graph or equation showing the relation between output and inputs F ( ) is a function that shows how inputs are combined to produce output “ A” is the level of technology “A” multiplies the function F( ), so improvements in technology (increases in “A”) allow more output (Y) to be produced from any given combination of inputs. L the quantity of labor, K the quantity of physical capital, H the quantity of human capital, and N the quantity of natural resources. 22

23. The Production Function Y = A F(L, K, H, N ) Many production functions have the property called constant returns to scale: Changing all inputs by the same percentage causes output to change by that percentage. Doubling all inputs (multiplying each by 2) causes output to double : 2 Y = A F (2 L , 2 K , 2 H , 2 N ) Increasing all inputs 10% (multiplying each by 1.1) causes output to increase by 10 %: 1.1Y = A F(1.1L, 1.1K, 1.1H, 1.1N ) 23

24. The Production Function Y = A F(L, K, H, N) If we multiply each input by 1/L, then output is multiplied by 1/L: Y/L = A F(1, K/L, H/L, N/L) This equation shows that productivity (Y/L, output per worker) depends on: The level of technology, A Physical capital per worker, K/L Human capital per worker, H/L Natural resources per worker, N,L 24

25. Active Learning 1 Discussion question Which of the following policies do you think would be most effective at boosting growth and living standards in a poor country over the long run? Offer tax incentives for investment by local firms Offer tax incentives for investment by foreign firms Give cash payments for good school attendance Crack down on government corruption Restrict imports to protect domestic industries Allow free trade 25

26. Economic Growth and Public Policy The ways public policy can affect long-run growth in productivity and living standards: Saving and investment Diminishing returns and the catch-up effect Investment from abroad; Education Health and nutrition Property rights and political stability Free trade; Research and development Population growth 26

27. Saving and Investment Raise future productivity Invest more current resources in the production of capital, K Trade-off : since resources scarce, producing more capital requires producing fewer consumption goods Reducing consumption = increasing saving This extra saving funds the production of investment goods ( More details in the next chapter .) 27

28. Diminishing Returns Policies that raise saving and investment Fewer resources are used to make consumption goods More resources: to make capital goods K increases, rising productivity and living standards This faster growth is temporary , due to diminishing returns to capital : As K rises, the extra output from an additional unit of K falls…. 28

29. Output per worker (productivity) The Production Function & Diminishing Returns 29 K / L Y / L Capital per worker If workers have little K , giving them more increases their productivity a lot. If workers already have a lot of K , giving them more increases productivity fairly little.

30. The catch-up effect : the property whereby poor countries tend to grow more rapidly than rich ones 30 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. K / L Y / L Poor country starts here Rich country starts here Poor country’s growth Rich country’s growth

31. Example of the Catch-Up Effect 1960–1990 The U.S. and S. Korea devoted a similar share of GDP to investment Expect: similar growth performance But growth was >6% in Korea and only 2% in the U.S. Explanation: the catch-up effect In 1960, K/L was far smaller in Korea than in the U.S., hence Korea grew faster 31

32. Investment from Abroad 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, e.g., Ford Motor Company builds a car factory in Mexico. Foreign portfolio investment Investment financed with foreign money but operated by domestic residents, e.g., an American might buy stock in a Mexican corporation (that is, buy a share in the ownership of the corporation), and the corporation can use proceeds from the stock sale to build a new factory. 32

33. Investment from Abroad Benefits from investment from abroad Some benefits flow back to the foreign capital owners Increase the economy’s stock of capital Higher productivity and higher wages State-of-the-art technologies developed in other countries Especially good for poor countries that cannot generate enough saving to fund investment projects themselves 33

34. Education (Human Capital) Education, investment in human capital Gap between wages of educated and uneducated workers In the U.S., each year of schooling raises a worker’s wage by 10 % Opportunity cost: wages forgone Spending a year in school requires sacrificing a year’s wages now to have higher wages later Human capital has positive externalities. An educated person, for example, might generate new ideas about how best to produce goods and services. Problem for poor countries: Brain drain 34

35. Health and Nutrition (Human Capital) Health care expenditure Is a type of investment in human capital: healthier workers are more productive In countries with significant malnourishment , raising workers’ caloric intake raises productivity: 1962–1995 , caloric consumption rose 44% in S. Korea, and economic growth was spectacular . 35

36. Health and Nutrition (Human Capital) Vicious circle in poor countries Poor countries are poor because their populations are not healthy Populations are not healthy because they are poor and cannot afford better healthcare and nutrition Economic Historian Robert Fogel in his Nobel prize speech said, “improved gross nutrition accounts for roughly 30 percent of the growth of per capita income in Britain between 1790 and 1980.” Virtuous circle Policies that lead to more rapid economic growth would naturally improve health outcomes, which in turn would further promote economic growth 36

37. Property Rights and Political Stability Markets are usually a good way to organize economic activity To foster economic growth Protect property rights (the ability of people to exercise authority over the resources they own) Courts – enforce property rights Promote political stability Property rights: Prerequisite for the price system to work 37

38. Property Rights and Political Stability Lack of property rights, a major problem Contracts are hard to enforce Fraud, corruption often goes unpunished Firms must bribe government officials for permits Political instability (e.g., frequent coups) Creates uncertainty over whether property rights will be protected in the future So, domestic residents will have less incentice to save and invest. Foreign investors will have less incentive to invest in the counry . 38

39. Property Rights and Political Stability When people fear their capital may be stolen by criminals/confiscated by a corrupt government Less investment, including from abroad, and the economy functions less efficiently Result : lower productivity, lower living standards Economic stability, efficiency, and healthy growth Require law enforcement, effective courts, a stable constitution, honest government officials 39

40. Free Trade Trade can make everyone better off Inward-oriented policies (Infant industry argument) i.e. tariffs , limits on investment from abroad Aim to raise living standards by avoiding interaction with other countries Outward-oriented policies i.e. elimination of restrictions on trade or foreign investment Promote integration with the world economy 40

41. Free Trade Trade has similar effects as discovering new technologies Improves productivity and living standards Countries with inward-oriented policies Have generally failed to create growth. e.g., Argentina during the 20th century. Countries with outward-oriented policies Have often succeeded e.g., South Korea, Singapore, Taiwan after 1960 41

42. Research and Development Technological progress Main reason why living standards rise over the long run Knowledge is a public good Ideas can be shared freely, increasing the productivity of many Policies to promote technological progress: Patent laws; Tax incentives or direct support for private sector R&D Grants for basic research at universities 42

43. Population Growth Large population More workers to produce goods and services: larger total output of goods and services More consumers Population growth may affect living standards in 3 different ways… 43

44. Population Growth Stretching natural resources 200 years ago, Malthus argued that population growth will: Strain society’s ability to provide for itself Mankind - doomed to forever live in poverty Since then, the world population has increased six fold and living standards increased Malthus failed to account for technological progress and productivity growth 44

45. Malthusian Trap and Technological Progress 45 Malthusian Population Trap-  The population threshold at which life-sustaining resources would no longer be able to support the human population, according to Malthus. Also known as the  low-level equilibrium trap.

46. Malthus (contd..) 46 The vertical distance between the two curves represents income per capita growth, which is total income growth less population growth. The population growth rate follows the  demographic transition  model, in which growth is low at very low incomes, very high once a minimum threshold is met, and then falls back to relatively stable.  The first intersection of stability is a state sustenance that has been the norm throughout history. Neo-Malthusians theorize that poor nations will never get past point S unless their is birth control or ‘Malthusian positive checks’–war, disease, etc. However, if a  nation can reach the point T, it enjoys steady continuous growth. Countries can do this using preventative checks (birth control), technology to boost the per capita income growth, or changing economic institutions and culture (“social progress”) to lower the population growth.

47. Malthus (contd..) How the technology spares the Malthusian population 47

48. Population Growth Diluting the capital stock High population growth (higher L) Spread the capital stock more thinly (lower K/L) Lower productivity and living standards To combat this, many developing countries use policy to control population growth Government regulation ( China’s one child law) Increased awareness of birth control Equal opportunities for women (Promote female literacy to raise opportunity cost of having babies ) 48

49. Population Growth Promoting technological progress World population growth Engine for technological progress and economic prosperity More people = More scientists, more inventors, more engineers = More frequent discoveries Michael Kremer, human history: Growth rates increased as the world’s population increased More populated regions grew faster than less populated ones 49

50. Active Learning 2 Review productivity concepts List the determinants of productivity. List three policies that attempt to raise living standards by increasing one of the determinants of productivity. 50

51. Active Learning 2 Answers Determinants of productivity : K/L , physical capital per worker H/L , human capital per worker N/L , natural resources per worker A , technological knowledge Policies to boost productivity: Encourage saving and investment, to raise K/L Encourage investment from abroad, to raise K/L Provide public education, to raise H/L Patent laws or grants, to increase A ( A patent is an exclusive right granted for an invention, which is a product or a process that provides, in general, a new way of doing something, or offers a new technical solution to a problem. To get a patent, technical information about the invention must be disclosed to the public in a patent application). Control population growth, to increase K/L 51

52. Are Natural Resources a Limit to Growth? Some argue that population growth Is depleting the Earth’s non-renewable resources And thus will limit growth in living standards. But technological progress often yields ways to avoid these limits: Hybrid cars use less gas. Better insulation in homes reduces the energy required to heat or cool them . 52

53. Are Natural Resources a Limit to Growth? Market economy, scarcity is reflected in market prices If the world were running out of natural resources, their prices would be rising over time In real terms, the prices of most natural resources are stable or falling It appears that our ability to conserve these resources is growing more rapidly than their supplies are dwindling Introduction of renewable substitutes to gasoline- ethanol. Ethanol is a renewable fuel  made from corn and other plant materials. Ethanol use is widespread, and more than 98% of gasoline in the U.S. contains some ethanol . Ethanol can be fermented from many sources of starch, including corn, wheat, grain sorghum, barley, and potatoes, and from sugar crops such as sugar cane and sweet sorghum. 53

54. Conclusion In the long run Living standards are determined by productivity Policies that affect the determinants of productivity Will therefore affect the next generation’s living standards One of these determinants: saving & investment Next chapter: how saving and investment are determined, and how policies can affect them 54

55. Summary There are great differences across countries in living standards and growth rates. Productivity (output per unit of labor) is the main determinant of living standards in the long run. Productivity depends on physical and human capital per worker, natural resources per worker, and technological knowledge. Growth in these factors—especially technological progress—causes growth in living standards over the long run. 55

56. Summary Policies can affect the following, each of which has important effects on growth: Saving and investment; International trade Education, health & nutrition Property rights and political stability Research and development Population growth Because of diminishing returns to capital, growth from investment eventually slows down, and poor countries may “catch up” to rich ones. 56