•Assignment 3--due Monday, February 13, 4:30pm
o Covers chapters 5 to 10
•In Class Exam: Wednesday February 15 or Wednesday Feb 29
Production and Growth: Chapter 7
What are the facts about:
What is productivity and why does it matter?
What is the relationship between productivity and living standards?
How can public policy affect productivity, growth, and living standards?
Incomes and Growth Around the World
There are vast differences in living standards around the world.
•The poorest countries have average levels of income that have not been seen in the
developed world for many decades.
There is also great variation in growth rates across countries.
•In Canada, over the past century average income has grown by about 2% per year, as
measured by real GDP per person.
Annual Growth Rates Matter!
Annual growth rates that seem small become large when compounded for many years.
Compounding refers to the accumulation of a growth rate over a period of time.
A growth rate of:
•2% per year means income doubles every 35 years
•7% per year means incomes double every 10 years
Standard of Living
Country's standard of living depends on its ability to produce goods and services.
•The key to raising living standards is "labour productivity"
•Labour productivity is defined as: the average quantity of goods and services produced
per unit of labour input
o Short hand definition:
• Output per worker
•In your book:
o Output is denoted by Y
o Labour is denoted by L
Output per worker is Y/L
What determines productivity?
•Is it people working harder and harder over time? No!
•Productivity is determined by the factors of production that workers have available to
•The factors of production are:
o Physical capital
o Natural Resources o Technological Knowledge
•The more of these each worker has to work with the higher the productivity.
Physical Capital per Worker
•Physical capital: stock of equipment and structures used to produce goods and services
o Capital is denoted by K
o K/L = capital per worker
•Productivity is higher when the average worker has more capital (machines, equipment,
etc.) to work with.
o An increase in K/L causes an increase in Y/L (productivity)
Human Capital per Worker
•Human capital: knowledge and skill workers acquire through education, training and
o Human capital denoted by H
o H/L = human capital per worker
•An increase in H/L causes an increase in Y/L (productivity)
Natural Resources per Worker
•Natural resources: inputs into production that nature provides, e.g. land, mineral
o Natural resources denoted by N
o N/L = natural resources per worker
•An increase in N/L causes an increase in Y/L
•Some countries are rich because they have abundant natural resources (e.g. Saudi
Arabia has lots of oil)
•But countries need not have much natural resources to be rich (e.g. Japan, Holland, etc.
import the N they need)
•Technological knwoledge: society's understanding of the best ways to produce goods
•Technological progress does not only mean a faster computer, a higher definition TV etc.
•It means any advance in knowledge that boosts productivity
o Any advance that allows society to get more output from its resources (e.g.
Henry Ford and the assembly line)
Technological Knowledge vs. Human Capital
Technological knowledge refers to society's understanding about how the world works
•Incorporating advances that allow society to get more output from its resources
Human capital refers to the resources expended transmitting this understanding to the labour
•Human capital is the skills that workers acquire through education, training and
The Production Function (FYI)
The production function shows the relation between outputs and inputs.
Y = A F (L, K, H, N)
•Y is output
•F () shows how inputs are combined to produce output •"A" - the level of technology
"A" multiplies the function F ( ), improvements in technology allow more outputs to be produced
from any given combinations of inputs
Typical Production Function
Y = A F(L, K, H, N)
•Y = quantity of output
•A = available production technology
•F() is a function that shows how the inputs are combined
Production Function with Constant Returns to Scale
Y = A F(L, K, H, N)
•Changing all inputs by the same percentage causes output to change by that percentage
•Doubling all inputs (x2) causes output to double
•If we multiply all inputs and outputs by 1/L, then…
o Y/L = A F (1, K/L, H/L, N/L)
•This shows that productivity depends on…
The level of technology: A
o Physical capital per worker - K/L
o Human capital per worker H/L
o Natural resources per worker N/L
Economic Growth and Public Policy
Next, we look at ways that public policy can affect long run growth in productivity and living
Or how Public Policy can affect the four factors of production.
List of government policies that can raise productivity and living standards
•Encourage greater saving and investment
•Promote investment from abroad
•Provide more education and training
•Ensure property rights and political stability
•Encourage free trade
•Support research and development
Investment in Physical Capital
•One way to boost productivity is to increase the physical capital stock, that is, K, or
physical capital per worker K/L
•However, there are two important features about physical capital that need to be kept in
o First, physical capital is a produced factor of production
Second, there are diminishing returns as the quantity of capital increases
•Society can change the amount of capital it has
•However, there is an opportunity cost of doing this:
o There is a tradeoff between current consumption and future consumption
If resources are used to produce capital goods, fewer goods and services can be
produced for current consumption o You have to consume less now (i.e. give up consumption) so that you can
consume more in the future
Tradeoff between Current and Future Consumption
Given: there is a fixed number of resources to produce g & s
Case 1: Use all the resources to produce g & s for current consumption
Case 2: use resources to produce:
• (1) some goods and services for current consumption
• (2) plus invest in production of physical capital
Looking Ahead: Saving, Investment and Capital Stock
Objective: to relate reduced consumption to saving to investnment to the capital stock
• We can boost productivity by increasing the capital stock (K)
• This requires investment:
Investment implies diverting som