CHAPTER 12

Outline:

Productivity – the quantity of goods &services produced from each unit of labor
input.

Determinants of Productivity:
– Physical capital, K (stock of equipment & structures that are used to
produce goods &services)
– Human capital, H (knowledge & skills that workers acquire through education
and experience)
– Natural resources, N (inputs into the production of goods &services that are
provided by nature)
– Technological knowledge, T (society’s understanding of the best ways to
produce g&S)
Y= A F (L,K,H,N) A- variable

Government Policies to raise Productivity:

– Saving & Investment (investing more current resources in the production
of capital)
• Since resources scarce, producing more capital requires producing fewer
consumption goods.
• Reducing consumption = increasing saving.
– Diminishing Returns ( the property whereby the benefit from an extra unit
of input declines as
the quantity of input increases. )
1) When the economy has a low level of capital, an extra unit of capital leads
to a large increase in output.
2) When the economy has a high level of capital, an extra unit of capital
leads to small increase in output.
*In other words, when workers already have a large amount of capital to use
in producing goods
& services, giving them an additional unit of capital increases their
productivity only slightly.
– Catch-up effect (the property whereby countries that start off poor tend to
grow more rapidly)
– Investment from Abroad
1) Foreign Direct Investment (a capital investment owned & operated by a
foreign entity)
Ex. Vaboo, a Finnish-owned auto manufacturer builds a production facility
in Kentucky.
2) Foreign Portfolio Investment (an investment that is financed with foreign
money but
operated by domestic residents.)
– Education (educated people generates new ideas about how best to produce
goods &services)
1) Externality  the effect of one person’s actions on the well-being of a
bystander.
2) Brain Drain  the emigration of many of the most highly educated
workers to rich countries
– Health & Nutrition (you need healthy people in the work environment)
– Research & development of new technologies

• Free Trade:
1) Inward-oriented policies – avoiding interaction with the rest of the world
2) Outward- oriented policies – interacting with other nations of the world

• Since growth rates vary, the country ranking can change over time.
– Poor countries are not necessarily doomed to poverty forever.
– Rich countries cannot take their status for granted, because they may be
overtaken by poorer but faster-growing countries.
• A country’s standard of living depends on productivity.

Exercises:
1) Consider two countries, Fritolaysia and Khandibar. Currently, real GDP per
person (average income) is $35,000 in Fritolaysia and $12,000 in Khandibar.
Over the past decade, real GDP per person grew at a rate of 1.4% in
Fritolaysia, and 2.6% in Khandibar.

-To project real GDP per person you use the following formula:

Average income in n years = (Current Average Income) x (1+g) ⁿ

(Where g – growth rate, and n – number of years)
Fritolays Khandibar
ia

Growth Rate 1.4% 1.1% 2.6% 2.1%

Average $140, 561 $104, 516 $156, 285 $95,886

Income
after 100
years

-If average income continues to grow at 1.4% per year in Fritolaysia, and
2.6% in Khandibar, real GDP per person in Fritolaysia will be less that the real
GDP per person in Khandibar after 100 yrs.
-If the growth of average income falls slightly to 1.1% per year in Fritolaysia,
and to 2.1% per year in Khandibar, real GDP per person in Fritolaysia this
time will be greater than real GDP per person in Khandibar after 1000 years.

2) The 4 determinants of productivity: physical capital, human capital, natural

resources, and technological knowledge.

• The looms used to weave the textiles the textiles are examples of physical
capital.
• A special technique that workers can use to create stronger textiles is an
example of technological knowledge.
• The training workers receive in order to use and repair the printing presses, is
an example of human capital.

1) Productivity and Growth

Year Physical Labor Force Labor Hours Output
Capital

2013 50 looms 20 workers 2,000 hours 4,500

garments

2014 60 looms 20 workers 2,000 hours 5,200

garments

Measure productivity based on the table above:

Year Physical Capital per Labor Productivity
Worker

2013 2.50 looms per worker 2.25 garments per hr of

labor

2014 3.00 looms per worker 2.60 garments per hr of

labor

*To find physical capital per worker you use physical capital & labor force:
Physical Capital per Worker 2013 = 50 looms / 20 workers = 2.50 looms per
worker

*To find labor productivity you use output and labor hours:
Labor Productivity in 2013 = 4,500 garments / 2,000 hrs of labor = 2.25
garments per hr of labor