Chapter 3

Production and Growth

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 ECONOMIC GROWTH
• Economic growth is an increase in the production of
economic goods and services, compared from one period of
time to another. It can be measured in nominal or real
(adjusted for inflation) terms.
Annual economic growth rate:

GDPt  GDPt 1
g  100%
GDPt 1
 Economic Growth around the World

• Real GDP per person

Living standard
Vary widely from country to country
• Growth rate
How rapidly real GDP per person grew in the typical year
• Because of differences in growth rates
Ranking of countries by income changes substantially
over time
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Table 1 The Variety of Growth Experiences

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 Economic growth rate in Vietnam

TUẦN 3 – SẢN XUẤT VÀ TĂNG TRƯỞNG 5

Real GDP per Capital
 QUESTIONS?

• Why are some countries richer than others?

• Why are some countries growing fast while others are still
trapped in poverty?
• What policies can help increase growth and living standards
in the long run?

TUẦN 3 – SẢN XUẤT VÀ TĂNG TRƯỞNG 7

 PRODUCTIVITY

TUẦN 3 – SẢN XUẤT VÀ TĂNG TRƯỞNG 8

 Factors of production

K = capital,
tools, machines, and structures used
in production

L = labor,
the physical and mental efforts of
workers

slide 9
 The production function
• denoted Y = F (K, L)
• shows how much output (Y ) the
economy can produce from
K units of capital and L units of labor.
• reflects the economy’s level of
technology.
• exhibits constant returns to scale.

slide 10
 Returns to scale: a review
Initially Y1 = F (K1 , L1 )
Scale all inputs by the same factor z:
K2 = zK1 and L2 = zL1
(If z = 1.25, then all inputs are increased by 25%)
What happens to output, Y2 = F (K2 , L2 ) ?
• If constant returns to scale, Y2 = zY1
• If increasing returns to scale, Y2 > zY1
• If decreasing returns to scale, Y2 < zY1

slide 11
The Sources of Long-Run
Growth
• Physical Capital
• (Machinery)
• Human Capital
• (Education)

• Technology
• (new methods of

production)
 Productivity
• Productivity
Quantity of goods and services
Produced from each unit of labor input
• Why productivity is so important
Key determinants of living standards
Growth in productivity is the key determinant of
growth in living standards
An economy’s income is the economy’s output
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 Productivity

• Determinants of productivity
 Physical capital per worker
 Human capital per worker
 Natural resources per worker
 Technological knowledge

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 Productivity

• Physical capital
Stock of equipment and structures
Used to produce goods and services
• Human capital
Knowledge and skills that workers acquire
through education, training, and experience

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 Productivity

• Natural resources
Inputs into the production of goods and services
Provided by nature, such as land, rivers, and
mineral deposits
• Technological knowledge
Society’s understanding of the best ways to
produce goods and services

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 Are Natural Resources a Limit to Growth?

• Argument
World’s population is almost 8 billion
Natural resources — will eventually limit how much the
world’s economies can grow
Fixed supply of nonrenewable natural resources – will
run out
Stop economic growth
Force living standards to fall
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 Are Natural Resources a Limit to Growth?

• Technological progress
• Often yields ways to avoid these limits
Improved use of natural resources over time
Recycling
New materials
• Are these efforts enough to permit continued economic
growth?

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 Are Natural Resources a Limit to Growth?

• Prices of natural resources

- Scarcity — reflected in market prices
- Natural resource prices
Substantial short-run fluctuations
Stable or falling — over long spans of time
- Our ability to conserve these resources
Growing more rapidly than their supplies are
dwindling
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 POLICIES

TUẦN 3 – SẢN XUẤT VÀ TĂNG TRƯỞNG 20

 Saving and Investment

• Raise future productivity

 Invest more current resources in the production of capital
 Trade-off
+ Devote fewer resources to produce goods and services
for current consumption

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 Diminishing Returns

• Higher savings rate

- Fewer resources – used to make consumption goods
- More resources – to make capital goods
- Capital stock increases
- Rising productivity
- More rapid growth in GDP

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 Diminishing Returns

• Diminishing returns
- Benefit from an extra unit of an input
- Declines as the quantity of the input increases
• In the long run, higher savings rate
- Higher level of productivity
- Higher level of income
- Not higher growth in productivity or income

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Figure 1 Illustrating the Production Function

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 Diminishing Returns
• Catch-up effect
- Countries that start off poor
- Tend to grow more rapidly than countries that start off
rich
• Poor countries
- Low productivity
- Even small amounts of capital investment
Increase workers’ productivity substantially
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 Diminishing Returns

• Rich countries
- High productivity
- Additional capital investment
 Small effect on productivity
• Poor countries
- Tend to grow faster than rich countries
 Investment from Abroad
• Investment from abroad
- Another way for a country to invest in new capital
- Foreign direct investment
+ Capital investment that is owned and operated by a
foreign entity
- Foreign portfolio investment
+ Investment financed with foreign money but
operated by domestic residents
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 Investment from Abroad

• Benefits from investment

- Some flow back to the foreign capital owners
- Increase the economy’s stock of capital
- Higher productivity
- Higher wages
- State-of-the-art technologies

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 Investment from Abroad

• World Bank
- Encourages flow of capital to poor countries
- Funds from world’s advanced countries
- Makes loans to less developed countries
 Roads, sewer systems, schools, other types of
capital
- Advice about how the funds might best be used

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 Investment from Abroad

• World Bank and the International Monetary Fund

- Set up after World War II
- Economic distress leads to:
Political turmoil, international tensions,
and military conflict
- Every country has an interest in promoting
economic prosperity around the world

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 Education

• Education
- Investment in human capital
- Gap between wages of educated and uneducated workers
- Opportunity cost: wages forgone
- Conveys positive externalities
- Public education – large subsidies to human-capital
investment
• Problem for poor countries: Brain drain
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 Health and Nutrition
• Human capital
- Education
- Expenditures that lead to a healthier
population
• Healthier workers
- More productive
• Wages
- Reflect a worker’s productivity
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 Health and Nutrition

• Right investments in the health of the population

- Increase productivity
- Raise living standards
• Historical trends: long-run economic growth
- Improved health – from better nutrition
- Taller workers – higher wages – better productivity

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 Health and Nutrition

• Vicious circle in poor countries

- Poor countries are poor
Because their populations are not healthy
- Populations are not healthy
Because they are poor and cannot afford better
healthcare and nutrition

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 Health and Nutrition

• Virtuous circle
- Policies that lead to more rapid economic growth
- Would naturally improve health outcomes
- Which in turn would further promote economic
growth

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 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

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 Property Rights, Political Stability

• Lack of property rights

- Major problem
- Contracts are hard to enforce
- Fraud goes unpunished
- Corruption
Impedes the coordinating power of markets
Discourages domestic saving
Discourages investment from abroad
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 Property Rights, Political Stability

• Political instability
- A threat to property rights
- Revolutions and coups
- Revolutionary government might confiscate the capital of
some businesses
- Domestic residents – less incentive to save, invest, and
start new businesses
- Foreigners – less incentive to invest
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 Free Trade

• Inward-oriented policies
- Avoid interaction with the rest of the world
- Infant-industry argument
Tariffs
Other trade restrictions
- Adverse effect on economic growth

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 Free Trade
• Outward-oriented policies
- Integrate into the world economy
- International trade in goods and services
- Economic growth
• Amount of trade – determined by
- Government policy
- Geography
Easier to trade for countries with natural seaports
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 Research and Development
• Knowledge – public good
- Government – encourages research and development
• Farming methods
• Aerospace research (Air Force; NASA)
• Research grants
+National Science Foundation
+National Institutes of Health
• Tax breaks
• Patent system
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 Population Growth
• Large population
- More workers to produce goods and services
Larger total output of goods and services
- More consumers
• Stretching natural resources
- Malthus: an ever-increasing population
Strain society’s ability to provide for itself
Mankind – doomed to forever live in poverty
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 Population Growth
• Diluting the capital stock
- High population growth
+ Spread the capital stock more thinly
+ Lower productivity per worker
+ Lower GDP per worker
• Reducing the rate of population growth
- Government regulation
- Increased awareness of birth control
- Equal opportunities for women
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 Population Growth

• Promoting technological progress

- World population growth
Engine for technological progress and economic
prosperity
More people = More scientists, more inventors,
more engineers

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