12 Production and Growth

Economic Growth Around the World Growth rate of real GDP over time Measures how rapidly real GDP per person grows over time Is the economy developing and how fast? Typically use average GDP growth rate over intervals of 5 or more years smooth out short-run fluctuations shows trend, or long-term, rate of growth

United States GDP Growth Rate The Gross Domestic Product (GDP) in the United States expanded 2.50 percent in the first quarter of 2013 over the previous quarter. (Bureau of Economic Analysis) Historically, from 1947 until 2013, US GDP Growth Rate averaged 3.23 all time high of 17.20 March of 1950 record low of -10.40 Percent in March of 1958. Finance, insurance, real estate, rental, leasing, health care, social assistance, professional, business and educational services account for more than 40 percent of GDP. Retail and wholesale trade creates another 12 percent of the wealth. Government related services fuel 13 percent of GDP. Utilities, transportation and warehousing and information 10 percent of the GDP. Manufacturing, mining, and construction 17 percent of the output. Agriculture 1.5 percent of the GDP, yet due to use of advance technologies, the United States is a net exporter of food.

Productivity: its Role and Determinants Quantity of goods and services produced from each unit of labor input (output per unit labor – hours?) Output per person (per hour) Increases in productivity due to: Improved technology “Working smarter” – better educated Why productivity is so important Key determinant of living standards

Productivity of Labor – output and labor Production Function: Output = F(inputs) Productivity of Labor – output and labor Output increases as labor increases But increases at a decreasing rate Average Output increases initially – scale effects Marginal Product of Labor measures how much each additional individual increases firm’s output Value theory of labor: wage = marg prod of labor

Productivity: its Role and Determinants How productivity is determined Physical capital Stock of equipment and structures Used to produce goods and services Human capital Knowledge and skills that workers acquire through education, training, and experience

Effect of an Increase in Capital (K) on Productivity of Labor Increase in education/training of workers -> similar effect

Productivity: its Role and Determinants How productivity is determined Natural resources Inputs into the production of goods and services Provided by nature, such as land, rivers, and mineral deposits Technological knowledge Society’s understanding of the best ways to produce goods and services

Economic Growth and Public Policy Diminishing returns and the catch-up effect Diminishing returns Marginal returns on investment: Benefit (increase in output) from an extra unit of an input of K Marg return declines as the quantity of the input increases More mature economies Smaller increases in productivity with Investment than “newer” industrializing economies

Illustrating the production function 1 Illustrating the production function Output per Worker 1 2. When the economy has a high level of capital, an extra unit of capital leads to a small increase in output. 1 1. When the economy has a low level of capital, an extra unit of capital leads to a large increase in output. Output per Worker This figure shows how the amount of capital per worker influences the amount of output per worker. Other determinants of output, including human capital, natural resources, and technology, are held constant. The curve becomes flatter as the amount of capital increases because of diminishing returns to capital

Economic Growth and Public Policy Diminishing returns and the catch-up effect Catch-up effect Countries that start off poor Tend to grow more rapidly than countries that start off rich Poor countries Low productivity Even small amounts of capital investment Increase workers’ productivity substantially

Economic Growth and Public Policy Diminishing returns and the catch-up effect Rich countries High productivity Additional capital investment Small effect on productivity Poor countries Tend to grow faster than rich countries

GNP Growth is Not Steady

Real GDP in the United States 2 Real GDP in the United States This figure shows quarterly data on real GDP for the U.S. economy since 1965. Recessions—periods of falling real GDP—are marked with the shaded vertical bars.

Real GDP (year to year) and Trend Rate of Growth

Productivity vs. Compensation Economic Policy Institute                                                                         

Measuring Income Inequality/Equality GINI Coefficient The most equal society will be one in which every person receives the same income (G = 0); the most unequal society will be one in which a single person receives 100% of the total income and the remaining people receive none (G = 1−1/N).

Most Unequal “Great Gatsby” era More equal distribution

Income Inequality in Developed Countries Using the Gini Coefficient (> G -> Grtr Inequality)

Economic Growth and Public Policy Saving and investment (in new technology) Raise future productivity Invest more current resources in the production of capital Trade-off Devote fewer resources to produce goods and services for current consumption Policy options Tax cuts for the rich as they save more (> .2) Savings incentives for all

Economic Growth and Public Policy Diminishing returns and the catch-up effect Higher savings rate More funds available for Investment Investment - > increase in Capital stock Rising productivity (technological shift) More rapid growth in GDP Increases current labor force’s productivity

The real middle-class challenge - Samuelson CEA found: that inequality isn’t the main cause of sluggish middle-class incomes. It’s poor productivity. Rhetorical solutions: more infrastructure spending; better schools; simpler taxes; more research. Though some policies may be desirable, there’s no guarantee they will improve productivity. Influencing productivity is hard because it depends on so much (management and workers, technology, market behavior, government policies and more).

Economic Growth and Public Policy Diminishing returns and the catch-up effect Diminishing returns Marginal returns on investment: Benefit (increase in output) from an extra unit of an input of K Marg return declines as the quantity of the input increases More mature economies Smaller increases in productivity with Investment than “newer” industrializing economies

Economic Growth and Public Policy Education Investment in human capital Gap between wages of educated and uneducated workers Opportunity cost: wages forgone Conveys positive externality Problem for poor countries Brain drain

Economic Growth and Public Policy Health and nutrition Healthier workers – more productive The right investments in the health of the population One way for a nation to increase productivity and raise living standards Historical trends: long-run economic growth Improved health - from better nutrition Taller workers – higher wages – better productivity

Economic Growth and Public Policy Health and nutrition Vicious circle in poor countries Are poor Because populations are not healthy Populations are not healthy Because they are poor Cannot afford better healthcare and nutrition

Economic Growth and Public Policy Property rights and political stability Foster economic growth Protect property rights Ability of people to exercise authority over the resources they own Courts – enforce property rights Promote political stability

Economic Growth and Public Policy Research and development Knowledge – public good Farming methods Aerospace research Air Force; NASA Research grants National Science Foundation National Institutes of Health Tax breaks Patent system

Economic Growth and Public Policy Population growth Large population Large labor force More consumers Stretching natural resources? Diluting the capital stock High population growth Reduces GDP per worker Promoting technological progress