Chapter 10: Economic Growth and Business Cycles 111
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labor productivity, we are interested in the amount of output produced by an hour of work. Thus,
anything that allows workers to produce more per hour, increases labor productivity. An increase
in capital is one reason workers could be more productive; if workers have more or better tools to
use they can produce more output per hour of work. Keep in mind that tools need not be physical.
Education and knowledge contribute to output as well. Smarter, better-trained, and more
experienced workers typically produce much more output in a given amount of time than novices
can. That is why, after all, people in a given job are usually paid more if they have more education
and experience. Economists call a person’s knowledge and experience human capital.
Finally, it is not just physical capital and human capital that increase labor productivity, but also
how work is organized. Producers, who can improve production methods, as Henry Ford did
when he manufactured cars using the assembly line, increase the productivity of their workers.
When other firms copy these techniques, the productivity of the entire economy increases.
In the mid-1990s, it appeared that productivity growth increased substantially in the U.S. economy.
Was there some revolutionary new invention, an increase in education, or an increase in capital that
caused this change? The answer is that all three were responsible for the observed productivity
growth, at least according to some economists who have studied the question. These economists
attribute the increase in productivity that began in the mid-1990s to the improved quality of capital
in the form of computers and software, combined with a more efficient means of employing
computers and software, along with training and experience of the workforce in using these new
tools.
We can conclude that changes in productivity drive changes in economic growth. The growth of
productivity has changed over the last fifty years, with more rapid growth in the economic liftoff
and the long boom than in the reorganization. But, is there any way to determine why productivity
growth changes over time? What economic forces lead to such changes? To answer those
questions, we need a model of economic growth, which we introduce next.
A Simple Model of Economic Growth
Economists have studied economic growth and its causes for many years. In 1958, Nobel laureate
Robert Solow proposed a simple way to identify some of the factors that cause the economy to
grow. His model has been modified and updated over the past forty-five years, but the basic idea of
the model remains clear and convincing. Output depends on the amount of capital and labor, and
businesses can only buy new capital if they can borrow from people who save.
Output in the Solow model is produced with capital and labor according to the production
function that we used earlier in equation
Yt = F(Kt, Lt), (7)
where we have added the subscripts t to indicate that the equation shows the relationship between
capital, labor, and output at a date t . The model is one that accounts for the movements of output,
capital, and labor over time, so the subscript is needed to keep track of the values of the variables
at different dates.