ECON 205 1st Edition Lecture 8Outline 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 inflationOutline 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 LectureProductivity- 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 workero Human Capital (H) Knowledge and skills workers acquire hrough education, training, and experience H/L= the average worker’s human capitalo 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 needo 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 lineo An increase in any of these factors increase productivity and growthSaving and Investment- Increasing K requires investment- When the government implements policies that encourages saving and investment, theyare also increasing K, productivity, and living standardso But the increase in growth is temporary Diminishing returns to capital- as K rises, theextra output from an additional unit of K falls Higher savings does not generate higher long-rungrowtho Because of the nature of the productivity curve, themore K increases, the less productivity grow (do notconfuse this with decreasing productivity)- Catch-up Effect- poor countries tend to grow more rapidly thanrich onesInvestment 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 residentsEducation- Education is a type of H- In the US, each year of schooling increases a worker’s wage by 10%- Education is also a tradeoffo Investing another year of education is giving up a year of workHealth & Nutrition- Health care is another type of H- Good health increases productivityProperty 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 rightso Lower investment, growth, a less efficient and stable economyFree Trade- Inward-oriented policies (i.e. tariffs)- aim to raise living standards by avoiding interactionwith other countrieso 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 standardsResearch 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 progresso Patent laws, tax incentives for private sectors grants for basic research at universitiesPopulation Growth- Stretches natural resourceso Fortunately, technological progress has made up for this- Dilutes capital stocko Higher L creates lower K/L and H/L- Promotes technological progresso More scientists, inventors, engineers lead to more