Chapter 12 Production and Growth 1 Economic growth Real GDP per person Living standard o o Vary widely from country to country Growth rate o How rapidly real GDP per person grew in the typical year Because of differences in growth rate rankings of countries by income change substantially over time Extreme poverty living on less than 2 a day most basic human needs determined by International Monetary Fund UN World Bank determined by average CPI of all countries Productivity Quantity of G S produced from each unit of labor input Average output of each unit produced Produced from each unit of labor input Why Productivity is So Important key determinant of living standards growth in productivity is the key determinant of growth in living standards an economy s income economy s output Determinants of productivity Physical capital per worker Human capital per worker experience Natural resources per worker Stock of equipment and structures used to produce G S o Knowledge and skills that workers acquire through education training ad Inputs into the production of G S provided by nature i e land rivers mineral reserves Technological knowledge Society s understanding of the best way to produce G S o o o Is a lack of natural resources a limit to growth Chapter 12 Production and Growth 2 Natural resources will eventually limit how much the world s economies can grow o o o Fixed supply of nonrenewable natural resources will run out Stop economic growth Forces living standards to fall Technological progress o Often yields ways to avoid these limits Improved use of natural resources over time Recycling New materials Prices of natural resources Scarcity reflected in market prices o o Natural resource prices Substantial short run fluctuations Stable of falling over long spans of time o Our ability to conserve these resources Growing more rapidly than their supplies are dwindling 1 Saving and Investment high savings rate better investment richer country Raise future productivity o o Invest more current resources in the production of capital Trade off Devote fewer resources to produce goods and services for current consumption Diminishing Returns benefit from an extra unit of an input declines as the quantity of the input increases Higher savings rate Fewer resources used to make consumption goods o o More resources to make capital goods o o Rising productivity o More rapid growth in GDP Higher savings rate in the long run Capital stock increases o Higher level of productivity income o Not higher growth in productivity or income Productivity Function increasing at decreasing rate Marginal productivity of labor assumes everything else is constant Chapter 12 Production and Growth 3 o o o o o o o o o o Catch up effect Poor countries Countries that start off poor tend to grow more rapidly than countries that start off rich Low productivity Even small amounts of a capital investment Increase workers productivity Tend to grow faster than rich countries Rich countries o High productivity o Additional capital investment Small effect on productivity In U S each year of schooling has historically raised a person s wage on average by 10 2 Investment from Abroad Another way for a country to invest in new capital Foreign direct investment Capital investment owned and operated by a foreign entity Investment financed with foreign money but operated by domestic residents Foreign portfolio investment Benefits form investment Some flow back to the foreign capital owners Increase the economy s stock of capital o o o Higher productivity Higher wages o State of the art technologies o Encourages flow of capital to poor countries o Funds from world s advanced countries o Makes loans to less developed countries World Bank Roads sewer systems schools other types of capital o Advice about how the funds might best be used World Bank and the International Monetary Fund Set up after WWII Economic distress leads to political turmoil international tensions military conflict Every country has an interest in promoting economic prosperity around the world philanthropy opens new markets politics 3 Education Education Investment in human capital o o Gap between wages of educated and uneducated workers o Opportunity cost wages forgone o Conveys positive externalities affecting people external of the direct consumer producers of a market e g decrease in crime Public education large subsidies to human capital investment o Problem for poor countries Brain Drain educated workers leave to richer countries 4 Health and Nutrition Human capital o Education Chapter 12 Production and Growth 4 o Expenditures that lead to a healthier population Healthier workers more productive Wages reflect a worker s productivity Right investments in the health of the population o Increase productivity o Raise living standards Historical trends long run economic growth o o o o o o o Improved health from better nutrition Taller workers average height of people in the country higher wages better productivity Vicious circle in poor countries Poor countries are poor b c their populations are not healthy Populations not healthy b c they are poor and cannot afford better healthcare and nutrition Virtuous circle Policies that lead to more economic growth o o Which would naturally improve health outcomes promotes economic growth 5 Property Rights Political Stability To foster economic growth Protect property rights 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 Lack of property rights o Major problem Contracts are hard to enforce o o Fraud goes unpunished Corruption Impedes the coordinating power of markets Discourages domestic saving Discourages investment from abroad Political Instability o A threat to property rights o Revolutions and coups o Revolutionary government might confiscate the capital of some businesses o Domestic residents less incentive to save invest and start new businesses o 6 Free trade Foreigners less incentive to invest Inward oriented policies o Avoid interaction with the rest of the world o Infant industry argument Tariffs taxes on imports government revenue allows infant industries to grow to height of foreign competition domestic protection Other trade restrictions o Adverse effect on economic growth Outward oriented policies o o o Integrate into the world economy International trade in G S Economic growth