Production and Growth

1. Principles of Macroeconomics (ECO 102)‏ Chapter 4 Production and Growth

2. Overview • Why does output per person differ across countries? • Why does economic growth differ across countries? • What determines productivity and growth?

4. Productivity in Bulgaria is low compared to EU:Gross Value Added per Worker (Euro1995)‏

5. per capita income

6. What determines productivity • Productivity = (average) amount of goods and services that a worker can produce from each hour of work. • Robinson combines several inputs or “factors of production” • Output depends on effort and on quality of other factors

7. Factors of production • Inputs used to produce goods and services are called the factors of production. • The Factors of Production • Physical capital • Natural resources (asset or curse?)‏ • Human capital • skills that workers acquire through education, training, and experience • Technological knowledge • Factors of Production determine productivity of a worker

8. Technological Knowledge • Society’s knowledge of how to produce goods and services. • Common knowledge • Proprietary knowledge • Distinguish between technological knowledge and human capital • Human capital: knowledge obtained by the labor force. • Konstantinople versus Rome

9. The Production Function • Relationship quantity of inputs (factors) used in production • quantity of output from production. • Key assumption: decreasing marginal productivity of each factor (separately)‏ • additional output for one additional factor unit • if all other input factors are given • one pizza shop, one pizza oven • marginal productivity of labor will decrease

11. The Production Function • Y = A F(L, K, H, N) • Y = quantity of output • A = available production technology • L = quantity of labor • K = quantity of physical capital • H = quantity of human capital • N = quantity of natural resources • F( ) is a function that shows how the inputs are combined.

12. The Production Function • A production function has constant returns to scale if, for any positive number x, xY = A F(xL, xK, xH, xN)‏ • Doubling of all inputs ⇒ output doubles

13. The Production Function and Productivity • Production functions with constant returns to scale: By setting x = 1/L, • Y/ L = A F(1, K/ L, H/ L, N/ L)‏ Where: Y/L = output per worker K/L = physical capital per worker H/L = human capital per worker N/L = natural resources per worker

15. Diminishing Returns and equilibrium growth • As capital stock rises, extra output produced from an additional unit of capital falls: • diminishing returns (to one factor, decreasing marginal productivity)‏ • Increase in the saving rate (coupled with increase in investment) leads to higher growth only for a while. • In the long run, higher saving rate leads to higher level of income, but nothigher growth. • poorer nations should be able to catch up

16. International flow of capital and the catch-up process • Capital should flow from where it is abundant (i.e. has relatively low marginal return) to where it is scarce (i.e. has relatively high marginal return)‏ • how globalized is the world today? • Long-term economic growth by attracting foreign investment • Investment from abroad takes several forms: • Foreign Direct Investment • Capital investment owned and operated by a foreign entity. • Foreign Portfolio Investment • Investments financed with foreign money but operated by domestic residents.

17. Are Natural Resources a Limit to Growth? • Malthus (1766-1834): population growth would tend to outgrow food-production • bringing population back to subsistence level • “Malthusian” model quite accurately tells the story of humanity from the beginning of agriculture to onset of industrial revolution. • modern version: finite non-renewable natural resources. • but price of a resource for which demand in the long run far exceeds supply should break all boundaries