Chapter 7: Production and Growth
An economy’s GDP measures both the total income earned in the economy and the
total expenditure on the economy’s output of goods and services.
The level of real GDP is a good gauge of economic prosperity.
The growth of real GDP is a good gauge of economic progress.
1. Examine international data on real GDP per person.
2. Examine the role of productivity-the amount of goods and services produced
for each hour of a worker’s time.
3. Consider the link between productivity and the economic policies that a
7-1: Economic Growth Around the World
The growth rate of a country measures how rapidly real income per person grew in
the typical year.
7-2: Productivity: Its Role and Determinants
Productivity is a summarized reason for why living standards vary so much around
7-2a: Why Productivity Is So Important
Productivity: The quantity of goods and services produced from each unit of labor
Productivity is the key determinant of living standards and that growth in
productivity is the key determinant of growth in living standards.
An economy’s GDP measures two things at once:
1. The total income earned by everyone in the economy.
2. The total expenditure on the economy’s output of goods and services.
These two things must be equal
Economy’s Income IS the Economy’s Output
A nation can enjoy a high standard of living only if it can produce a large quantity of
goods and services.
7-2b: How Productivity Is Determined
Productivity is determined by the factors of production:
1. Physical Capital
Physical Capital: The stock of equipment and structures that are used to
produce goods and services. It can be referred to as just capital.
• Workers are more productive when they have tools with which to
work. The better the tools, the more output there would be.
• An important feature of capital is that it is a produced factor of
production. This means that it is an input into the production process
that in the past was an output from the production process.
• Capital is a factor of production used to produce all kinds of goods and
services, including more capital. 2. Human Capital
Human Capital: The knowledge and skills that workers acquire through
education, training, and experience.
Like physical capital, human capital is a produced factor of production.
Human capital refers to the resources expended transmitting this
understanding to the labor force.
3. Natural Resources
Natural Resources: The inputs into the production of goods and services that
are provided by nature, such as land, rivers, and mineral deposits.
Two Forms of Natural Resources:
Natural resources are not necessary for an economy to be highly productive
in producing goods and services.
4. Technological Knowledge
Technological Knowledge: Society’s understanding of the best ways to
produce goods and services.
Tech knowledge refers to society’s understanding of how the world works.
The Production Function
It describes the relationship between the quantity of inputs used in production and
the quantity of output from production.
Y = AF(L, K, H, N)
Y-Quantity of Output
L-Quantity of Labor
K-Quantity of Physical Capital
H-Quantity of Human Capital
N-Quantity of Natural Resources
F()-A function that shows how the inputs are combined to produce output.
A-A variable that reflects the available production technology.
When technology improves, A rises.
The economy produces more output from any given combination of inputs.
Many production functions have a property called constant returns to scale.
If a production function has constant returns to scale. Then doubling all
inputs causes the amount of output to double as well.
Mathematically, we write that a production function has constant returns to
scale if, for any positive number x,
xY = AF(xL, xK, xH, xN)
A doubling of all inputs would be represented by this equation by x = 2. The
right side shows the inputs doubling, and the left side shows output doubling.
Set x = 1/L so that the preceding equation becomes
Y/L = AF(1, K/L, H/L, N/L)
Y/L-Output Per Workers, a measure of productivity.
This equation says that labor productivity depends on
Physical Capital Per Worker (K/L), Human Capital Per Worker (H/L), and
Natural Resources Per Worker (N/L)
State of Technology A.
7-3: Economic Growth and Public Policy
What can government policy do to raise productivity and living standards?
7-3a: Saving and Investment
One way to raise future productivity is to invest more current resources in the
production of capital.
For society to invest more in capital, it must consume less and save more of its
Encouraging saving and investment is one way that a government can encourage
growth and, in the long run, raise an economy’s standard of living.
7-3b: Diminishing Returns and the Catch-Up Effect
Diminishing Returns: The property whereby the benefit from an extra unit of an
input declines as the quantity of the input increases.
Another way to define D.R. is, as the stock of capital rises, the extra output
produced from an additional unit of capital falls.
In other words, when workers already have a large quantity of capital to use
in producing goods and services, giving them an additional unit of capital
increases their productivity only slightly.
Illustrating the Production Function:
This shows how the amount of capital per worker influences the amount o