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Chapter 7

Production and Growth - Chapter 7.docx

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York University
ECON 1010
Frank Miller

Production and Growth - Large difference in income reflected in large differences in quality of life; richer countries have greater access to resources and better infrastructure in place - Standard price indexes comparing sums of money from different points in time are overestimated - Rate of real economic growth is underestimated Productivity: It’s Role and Determinants Importance of Productivity - If an economy is good at producing goods and services, it will strive - If an economy gets to consume only what it produced, the standard of living would be tied to productivity - Productivity: amount of goods/services produced for each hour of a worker’s time - Increase in productivity makes an economy better off; produce more by spending less time in production; devote saved time to other activities - For an economy, it’s total income is its total output - Nations can enjoy high standard of living with high productivity How Productivity is Determined Physical Capital per Worker - Workers can be more productive if they have the right tools - Physical capital: stock of equipment and structures that are used to produce goods and services - Workers with sophisticated, specialized and plentiful tools are more productive - Factors of production: inputs used to produce goods and services - Capital: factor of production used to produce all kinds of goods and services, including more capital resources Human Capital per Worker - Knowledge and skills that workers acquire though education, training and experience - Includes skills accumulated in early programs, school and on the job training - Raises nation’s ability to produce goods/services and it is a produced factor of production (requires inputs from teachers and libraries) Natural Resources per Worker - Inputs into production that are provided by nature; land, river, mineral deposits - Can be both renewable and non-renewable - Canada has a lot of land suited for agriculture as well as acquires abundance of mineral, forest and oil deposits Technological Knowledge - Understanding of the best ways to produce goods and services - Common knowledge: used by some and slowly everyone becomes aware of it - Proprietary knowledge: known only by the company that discovers it - Refers to society’s understanding about how the world works - Human capital refers to resources expended transmitting this understanding to the labour force - Knowledge is the quality of society’s textbooks; human capital is the amount of time that population has devoted to reading them Production Function - Used to describe relationship between quantity of inputs used in and quantity of outputs obtained from production - Y (output), L (labour), K (physical capital), H (human capital), NN (natural resources), A (variable reflective available production technology) - Y = A F (l, K, H, N) o As technology improves, A rises, economy produces more output from any combination of inputs o Constant returns to scale: doubling all inputs causes output to double as well  xY = A F (xL, xK, xH, xN) Concern for depleting resource quantities (Long-run) - Technological innovation and advances present access to resources and allowed us to reuse some non- renewable resources; through recycling and other initiatives - Development of alternative fuels instead of gasoline provide us with renewable substitutes - Scarcity is reflected in market prices: if world was running on short supply price would sky-rocket - World’s ability to conserve these resources is growing with time; market prices do not present a reason to believe that natural resources are limit to economic growth Economic Growth and Public Policy Importance of Saving and Investment - Producing larger quantity of new capital goods, allows nations to have larger stock of capital and be able to produce more of all types of goods and services - Essential to invest more current resources in production of capital - Society must then consume less and save more of its current income Diminishing Returns and Catch-up Effect - Savings rate: percent of GDP devoted to saving rather than consumption - Saving would lead to increase in capital stock; increase productivity and more rapid growth in GDP - Diminishing returns: benefit from an extra unit of an input declines as the quantity of input increases; hold other determinants constant o Due to this, increase in saving rate leads to higher growth only for a while; benefits from additional capital become smaller over time o In long run, higher saving rate leads to higher level of productivity and income, but not higher growth in these variables o Diminishing returns states that it is easier to grow fast, holding other things equal, if it starts out poor  Catch-up effect: property whereby countries that start off poor tend to grow more rapidly than those that start off rich  Small amounts of capital investments would substantially increase productivity  In rich nations, productivity is already high, increase in level of capital has minute effect of production Investment from Abroad - Foreign direct investment: capital investment that is owned and operated by a foreign entity - Foreign portfolio investment: investment that is financed with foreign money, but operated by domestic residents o Companies can invest in other nations (build manufacturing plant) or buy stocks of foreign companies o Foreign investment is driven by expectancy of earning a return on investment o Opening assembly plant in another nation – foreign investment raises income of foreign citizens (measured by GNP) by less than it raises production in foreign nation (measured by GDP) - Investment leads to higher wages, productivity and growth; despite investment flowing back to home country - Investment allows poor countries to recognize new technologies - World Bank: organization that tries to encourage flow of capital to poor countries o Obtains funds from advanced nations and uses resources to make loans t
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