ECON 205 1st Edition Lecture 8 Outline of Last Lecture How does Consumer Price Index CPI measure change in cost of living How does CPI compare with GDP deflator Using the CPI to compare dollar values over time and correct for inflation Outline of Current Lecture How do standards of living and growth differ around the world Productivity is a key determinant of living standards What determines productivity and its growth How does public policy affect standard of living Current Lecture Productivity High productivity means real GDP is large and incomes are high Productivity and living standards positively correlate Determinants of Productivity and its Growth o Physical Capital K Stock of equipment and structures used to produce goods and services K L capital per worker o Human Capital H Knowledge and skills workers acquire hrough education training and experience H L the average worker s human capital o Natural Resources N The inputs into production that nature provides land mineral deposits etc Some countries rich because they have abundant natural resources but others can easily import the natural resources they need o Technological knowledge Society s understanding of the best way s to produce Goods and Services Any advance in knowledge that boosts productivity Not just faster computers but methods like the assembly line o An increase in any of these factors increase productivity and growth Saving and Investment Increasing K requires investment When the government implements policies that encourages saving and investment they are also increasing K productivity and living standards o But the increase in growth is temporary Diminishing returns to capital as K rises the extra output from an additional unit of K falls Higher savings does not generate higher long run growth o Because of the nature of the productivity curve the more K increases the less productivity grow do not confuse this with decreasing productivity Catch up Effect poor countries tend to grow more rapidly than rich ones Investment from Abroad Foreign direct investment a capital investment i e factory that is owned and operated by a foreign country Foreign portfolio investment a capital investment financed with foreign money but operated by domestic residents Education Education is a type of H In the US each year of schooling increases a worker s wage by 10 Education is also a tradeoff o Investing another year of education is giving up a year of work Health Nutrition Health care is another type of H Good health increases productivity Property Rights Ability of people to exercise authority over the resources they own Poor countries lack respect for property rights due to contracts that aren t enforced fraud and corruption Political instability creates uncertainty over the protection of property rights o Lower investment growth a less efficient and stable economy Free Trade Inward oriented policies i e tariffs aim to raise living standards by avoiding interaction with other countries o Countries with this policy usually fail to create growth Outward oriented policies i e elimination of restrictions on trade or foreign investment promote integration with the world economy Trade also improves productivity and living standards Research and Development Technological progress is the main reason why living standards rise over the long run Knowledge is a public good because ideas can be shared freely increasing the productivity of many Policies to promote technological progress o Patent laws tax incentives for private sectors grants for basic research at universities Population Growth Stretches natural resources o Fortunately technological progress has made up for this Dilutes capital stock o Higher L creates lower K L and H L Promotes technological progress o More scientists inventors engineers lead to more discoveries