Econ 2 Lecture 3 Notes (Chapter 25)
Econ 2 Lecture 3 Notes (Chapter 25) ECON 2
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This 6 page Class Notes was uploaded by Anna on Wednesday October 12, 2016. The Class Notes belongs to ECON 2 at University of California - Los Angeles taught by Rojas in Fall 2015. Since its upload, it has received 6 views. For similar materials see Principles of Economics in Economcs at University of California - Los Angeles.
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Lecture 3: Production and Growth (Chapter 25) 1. Incomes and Growth Around the World a. GDP and growth rate are not necessarily correlated i. Not starting at same point ii. More room to grow in developing countries → growth rate high while GDP low and vice versa 2. Productivity a. Average quantity of goods/services produced per unit of labor b. A country’s standard of living depends on its ability to produce goods/services c. Productivity = Y/L (output per worker) i. Y = real GDP = quantity of output produced ii. L = quantity of labor 3. Why Productivity Is So Important a. High productivity = high real GDP b. When productivity grows rapidly, so do living standards c. Factors that influence productivity and its growth rate i. Physical Capital per Worker (K) ○ The stock of equipment and structures used to produce goods/services (machines, etc) ○ K/L = Capital per worker ○ More capital per worker → higher productivity ○ Increase in K/L → increase in Y/L ii. Human Capital per Worker (H) ○ Knowledge and skills workers acquire through education, training, and experience ➢ Ex: programming ○ H/L = the average worker’s human capital ○ More human capital → higher productivity ○ Increase in H/L → increase in Y/L iii. Natural resources per Worker (N) ○ Inputs into production that nature provides (land, mineral deposits) ○ Other things equal, more N → produce more Y ○ Increase in N/L → increase in Y/L ○ Some countries are rich because they have abundant natural resources (Saudi Arabia) ○ Countries need not have much N to be rich (Japan) iv. Technological knowledge ○ Society’s understanding of the best ways to produce goods/services ○ Does not only mean faster computer, smarter cell phone, etc ○ Means any advance knowledge that boosts productivity (allow society to get more output from its resources) ○ Ex: Henry Ford and assembly line v. Government policy vi. Education d. Technological knowledge vs. Human capital i. Technological knowledge refers to society’s understanding of how to produce goods and services ii. Human capital results from the effort people expend to acquire this knowledge ○ Going further in education → increase human capital 4. The Production Function a. Graph or equation showing relation between output and inputs b. Y = A x F(L, K, H, N) i. F( ) - function that shows how inputs are combined to produce respective output ii. A - level of technology ○ All else equal, A scales production function iii. A x F( ) - increases in A (improvements in technology) → increase Y (more output produced from any given combination of inputs c. Has constant returns to scale - changing all inputs by the same percentage causes output to change by that percentage i. Doubling all inputs or level of technology (A) causes output to double ○ 2Y = A x F(2L , K, H, ) ○ 2Y = 2 A x F(L, K, H, N) d. Multiply each input by 1/L → output is multiplied by 1/L i. Y/L = A x F(1, K/L, H/L, N/L) ○ Shows that productivity depends on ➢ level of technology ➢ physical capital per worker ➢ human capital per worker ➢ natural resources per worker 5. Discussion Question a. Which of the following policies do you think would be most effective at boosting growth and living standards in a poor country over the long run? i. Allow free trade ○ Natural resources - import resources that country initially did not have ○ Technology - can import machines/tools that can increase productivity ii. Offer tax incentive for investment by local firms ○ Human capital - offering more training for workers 6. Economic Growth and Public Policy a. Saving and Investment i. Boost productivity by increasing K, which requires investment ii. Reducing consumption → increasing saving ○ Producing more capital requires producing fewer consumption goods ○ Extra saving funds production of investment goods iii. Tradeoff between current and future consumption ○ Ex: retirement - how much you are saving now can be seen as an investment toward your future b. Diminishing Returns and the Catch-Up Effect i. Government can implement policies that raise saving and investment (Fed, fiscal policy) ○ Increase K → increase productivity and living standards ○ Ex: Recession - government put more money into economy → increase spending → increase consumption → stimulate economy ii. Faster growth is temporary due to diminishing returns to capital ○ As K rises, extra output from additional unit of K falls iii. If workers have little K, give more → increases productivity a lot iv. If workers already have a lot of K, give more → increases productivity fairly little v. Catch-up effect - property whereby poor countries tend to grow more rapidly than rich ones ○ Ex: 1960-1990, U.S. and South Korea devoted similar share of GDP to investment, but >6% growth in S. Korea and only 2% in U.S. ➢ In 1960, K/L was far smaller in Korea than in the U.S., hence Korea grew faster c. Investment from Abroad i. To raise K/L, government can encourage… ○ Foreign direct investment - capital investment that is owned and operated by foreign entity ➢ Ex: Apple builds factory in China ○ Foreign portfolio investment - capital investment financed with foreign money but operated by domestic residents ➢ Ex: U.S. citizen buys stock in a Korean company ii. Especially beneficial in poor countries that cannot generate enough saving to fund investment projects themselves iii. Helps poor countries learn state-of-the-art technologies developed in other countries iv. Gross national product (GNP) - income earned by residents of a country both at home and abroad ○ Ford open car factory in Mexico -- GNP less than GDP because some of income generated accrues to people not living in Mexico d. Education i. Government can increase productivity by promoting education- investment in human capital (H) ii. Public schools, subsidized loans for college iii. Effects: decrease in crime rates, raise worker’s wage iv. Investing in H involves trade off between present & future ○ Spending year in school requires sacrificing a year’s wages now e. Health and Nutrition i. Type of investment in human capital- healthy workers are more productive ii. In countries with significant malnourishment, raise workers’ calorie intake → increase productivity 7. Property Rights and Political Stability a. Stable government that enforce property rights- ability of people to exercise authority over the resources they own b. In many poor countries, justice system does not work very well i. Contracts not enforced ii. fraud/corruption goes unpunished iii. Firms bribe government officials for permits c. Political instability (like frequent coups) creates uncertainty over whether property rights will be protected in the future d. Result: lower living standards e. Corrupt government → people scared → less investment → less efficient economy 8. Free Trade a. Inward-oriented policies - aim to raise living standards by avoiding interaction with other countries i. Ex: tariffs, limits on investment from abroad ii. Would require country to be self sufficient-- no specialization iii. Generally fail to create growth (Argentina) b. Outward-oriented policies - promote integration with the world economy i. Ex: Elimination of restrictions on trade or foreign investment ii. Countries with this kind of policy often succeed (South Korea, Singapore, Taiwan) c. Trade has similar effect as discovering new technology-- improves productivity and living standards 9. Research and Development a. Knowledge is public good because ideas can be shared freely → increase productivity of many b. Policies to promote tech i. Patent laws ii. Tax incentives or direct support for private sector research/development iii. Grants for basic research at universities 10. Population Growth a. Stretching natural resources i. Living standards actually increase because of technological progress and productivity growth ii. Diluting capital stock ○ Bigger population → higher L → lower K/L → lower productivity/living standards ○ Applies to H as well-- fast population growth → more children → ○ Countries with fast population growth tend to have lower educational attainment ○ Developing countries use policies to control population growth ➢ China’s one child per family laws → problematic because now deficit of young workers ➢ Contraception education & availability ➢ Promote female literacy to raise opportunity cost of having babies iii. Promoting technological progress ○ More people → ➢ more scientists, inventors, engineers ➢ more frequent discoveries ➢ Faster technological progress & economic growth 11. Are Natural Resources a Limit to Growth? a. Some argue population growth depleting resources → limit growth in living standards b. But technological progress yields ways to avoid limits i. Hybrid cars use less gas ii. Better insulation in homes reduces energy required to heal to cool them c. Resource become scarcer → market price rise → increase incentive to conserve + develop alternatives