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Chapter 25

Chapter 25 Economics.docx

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Harvard University
Economics 10b
Gregory Mankiw

Chapter 25 Economics: Production and Growth • Over the past century, average income as measured by real GDP per person has grown by about 2 percent per year, giving the averageAmerican an income double what it would have been 35 years ago (more prosperity than previous generations) • The level of real GDP is a good gauge of economic prosperity, and the growth of real GDP is a good gauge of economic progress • The variation in living standards around the world can be attributed to a country’s productivity • Productivity: the quantity of goods and services produced from each unit of labor input • An economy’s income is an economy’s output • Physical capital: the stock of equipment and structures that are used to produce goods and services o More tools or better technology increase productivity o Factors of production: the inputs used to produce goods and services (labor, capital, etc.) o Capital is a produced factor of production; it is an input into the production process that in the past was an output from the production process • Human capital: the knowledge and skills that workers acquire through education, training, and experience o Similar to physical capital in that it raises a nation’s ability to produce goods and services; also, human capital is a factor of production (it requires inputs) • Natural resources: the inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposits o Natural resources take two forms: renewable (forest) and nonrenewable (oil) • Technological knowledge: society’s understanding of the best ways to produce goods and services o Common knowledge: after one person uses the technology, everyone becomes aware of it o Proprietary knowledge: it is known only by the company which discovers it  It can be proprietary under a time constraint or not  The patent system gives that company a temporary right to be an exclusive manufacturer • Difference between technological knowledge and human capital o Technological knowledge: refers to society’s understanding about how the world works o Human capital: refers to the resources expended transferring this understanding to the labor force • Y=quantity of output; L=quantity of labor; K=quantity of physical capital; H=quantity of human capital; N=quantity of natural resources o Y=AF(L, K, H, N) where F is a function that shows how inputs produce outputs o Ais a variable that reflects the available production technology withA rising as technology improves, demonstrating that the economy produces more output from a given combination of inputs o Many production functions have constant return to scale (doubling inputs, doubles outputs) xY=AF(xL, xK, xH, xN)  If you set x=1/L, then you can measure labor productivity • Technological progress helps to mitigate the depletion of natural resourcesconservation is rising faster than usage of natural resources • Natural resource prices exhibit substantial short-run fluctuations, but over the long run remain relatively stable or falling • One way to raise future productivity is to invest more current resources in the production of capital o For society to invest more in capital, it must consume less and save more of its current incomepreparing for greater consumption in the future • When a nation’s population saves more money, fewer resources are needed to make consumption goods and more resources are available to make capital goodscapital stock increases as does productivity and growth of GDP • Diminishing returns: the property whereby the benefit from an extra unit of an input declines as the quantity of the input increases o As the stock of capital rises, the extra output produced from an additional unit of capital increases their productivity only slightly o An increase in the saving rate causes higher growth (sometimes even over decades) o In the long run, the higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables • Catch-up effect: the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich (when controlling for other variables like percentage GDP devoted to investment) o Small amounts of capital investment would substantially raise the workers’ productivity (rudimentary toolslower productivity; better technologyhigher productivity) • Saving by domestic residents as well as investment by foreigners can increase long-term economic growth o Foreign direct investment: a capital investment that is owned and operated by a foreign entity o Foreign portfolio investment: an investment that is financed with foreign money but operated by domestic residents o When foreigners invest in a country, they do so because they expect to earn a return on their investment o Foreign investment in country X raises the income of citizens of country X (measured by GNP) by less than it raises the production in country X (measured by GDP)  When Ford opens its car factory in Mexico, some of the income the factory generates accrues to people who do not live in Mexico o Foreign investment increases the economy’s stock of capital, leading to higher productivity and higher wages o Foreign investment also allows for technology transfer and spillover  This is why many economists suggest that developing nations accept offers of foreign investment by lifting restrictions on foreign ownership of domestic capital o The World Bank obtains funds from the world’s advanced countries and uses these resources to make loans to less developed countries so that they can invest in roads, sewer systems, schools, and other types of capital; it also advises developing nations on how to use the funds o The World Bank and the International Monetary Fund were set up after WWII in order to avoid the economic distress that led to political turmoil and military conflict • Education o In the U.S., each year of schooling has historically raised a person’s wage by an average of about 10 percent o In developing nations, where human capital is especially scarce, the gap between the wages of educated and uneducated workers is larger o To raise the standard of living, governments should advocate for citizens to take advantage of the good schools it has created o Opportunity cost of education: When students are in school, they forgo the wages they could have earned as members of the labor force  In developing nations, children drop out of school earlier because the opportunity cost of wages lost is too high o Education creates many positive externalities, which is why economists argue that it should be so important to citizens  An educated person might generate new ideas about how best to produce goods and servicesthese ideas enter society’s pool of knowledge so that everyone can use thempositive externality o Brain drain: a problem faced by developing nations in which many of the most highly educated workers emigrate to rich countries where citizens enjoy higher standards of living  Do countries send their best students to attend a better university in a developed nation, understanding that the student might not return to developing nation? This would reduce the stock of human capital and make the poor even poorer. • Health and Nutrition: expenditures can also lead to a healthier population o Healthier workers are more productivemore productivity raises living standards o Robert Fogel (economic historian): a significant factor of long-run economic growth is improved health from better nutrition  More people are capable of manual labor or receiving an educationmore energy from better nutrition, less sickness from better healthhigher productivity  Won Nobel Prize in Economics in 1993  “Improved gross nutrition accounts for roughly 30 percent of the growth of per capita income in Britain between 1790 and 1980” o Better nutrition during developmental periods leads to an increase in height, which is an indicator in productivity (taller workers earn more) o Poorer countries are poor in part bec
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