Chapter 12

Describe capital:

-An important feature of capital is that it is a produced factor of production. -That is, capital is an input into the production process that in the past was an output from the production process

What are determinants of productivity?

-physical capital, -human capital -natural resources -technological knowledge

Foreign portfolio investment

An investment financed with foreign money but operated by domestic residents

inward-oriented policies

aim to increase productivity and living standards within the country by avoiding interaction with the rest of the world. -Domestic firms often advance the infant-industry argument, claiming that they need protection from foreign competition to thrive and grow. Together with a general distrust of foreigners, this argument has at times led policymakers in less developed countries to impose tariffs and other trade restrictions.

outward-oriented policies

integrate these countries into the world economy. International trade in goods and services can improve the economic well-being of a country's citizens. -Trade is, in some ways, a type of technology. When a country exports wheat and imports textiles, the country benefits as if it had invented a technology for turning wheat into textiles. A country that eliminates trade restrictions will, therefore, experience the same kind of economic growth that would occur after a major technological advance.

Describe free trade:

inward-oriented policies- aim to increase productivity and living standards within the country by avoiding interaction with the rest of the world. >>>>Domestic firms often advance the infant-industry argument, claiming that they need protection from foreign competition to thrive and grow. Together with a general distrust of foreigners, this argument has at times led policymakers in less developed countries to impose tariffs and other trade restrictions. outward-oriented policies- integrate these countries into the world economy. International trade in goods and services can improve the economic well-being of a country's citizens. >>>>Trade is, in some ways, a type of technology. When a country exports wheat and imports textiles, the country benefits as if it had invented a technology for turning wheat into textiles. A country that eliminates trade restrictions will, therefore, experience the same kind of economic growth that would occur after a major technological advance.

public goods

one person discovers an idea, the idea enters society's pool of knowledge and other people can freely use it. Just as government has a role in providing a public good such as national defense, it also has a role in encouraging the research and development of new technologies.

property rights

refer to the ability of people to exercise authority over the resources they own.

Technological knowledge

society's understanding of the best ways to produce goods and services -Today, thanks to advances in farm technology, a small fraction of the population can produce enough food to feed the entire country. This technological change freed up labor, which could then be used to produce other goods and services. -Technological knowledge takes many forms. Some technology is common knowledge—after one person uses it, everyone becomes aware of it.

natural resources

the inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposits -take two forms: renewable and nonrenewable. A forest is an example of a renewable resource. When one tree is cut down, a seedling can be planted in its place to be harvested in the future. Oil is an example of a nonrenewable resource. Because oil is produced by nature over many millions of years, there is only a limited supply. Once the supply of oil is depleted, it is impossible to create more. -Differences in natural resources are responsible for some of the differences in standards of living around the world. The historical success of the United States was driven in part by the large supply of land well suited for agriculture. Today, some countries in the Middle East, such as Kuwait and Saudi Arabia, are rich simply because they happen to be on top of some of the largest pools of oil in the world.

Factors of production

the inputs used to produce goods and services—labor, capital

human capital

the knowledge and skills that workers acquire through education and on-the-job training -includes the skills accumulated in early childhood programs, grade school, high school, college, and on-the-job training for adults in the labor force. -human capital raises a nation's ability to produce goods and services. -human capital is a produced factor of production. Producing human capital requires inputs in the form of teachers, libraries, and student time. Indeed, students can be viewed as "workers" who have the important job of producing the human capital that will be used in future production.

productivity

the quantity of goods and services produced from each unit of labor input. -productivity is the key determinant of living standards and that growth in productivity is the key determinant of growth in living standards. -Productivity's key role in determining living standards is as true for nations

Physical capital

the stock of equipment and structures that are used to produce goods and services

Describe investments from abroad:

-A capital investment that is owned and operated by a foreign entity is called foreign direct investment. Alternatively, an American might buy stock in a Mexican corporation (that is, buy a share in the ownership of the corporation), and the corporation can use the proceeds from the stock sale to build a new factory. An investment financed with foreign money but operated by domestic residents is called foreign portfolio investment. In both cases, Americans provide the resources necessary to increase the stock of capital in Mexico. That is, American saving is being used to finance Mexican investment. -When foreigners invest in a country, they do so because they expect to earn a return on their investment. -Investment from abroad, therefore, does not have the same effect on all measures of economic prosperity. Recall that a country's gross domestic product (GDP) is the income earned within the country by both residents and nonresidents, whereas a country's gross national product (GNP) is the income earned by residents of the country both at home and abroad. -investment from abroad is one way for a country to grow. Even though some of the benefits from this investment flow back to the foreign owners, this investment does increase the economy's stock of capital, leading to higher productivity and higher wages. Moreover, investment from abroad is one way for poor countries to learn the state-of-the-art technologies developed and used in richer countries. For these reasons, many economists who advise governments in less developed economies advocate policies that encourage investment from abroad. Often, this means removing restrictions that governments have imposed on foreign ownership of domestic capital.

Distinguish between technological knowledge and human capital:

-They are closely related, but there is an important difference. -Technological knowledge refers to society's understanding about how the world works. -Human capital refers to the resources expended transmitting this understanding to the labor force. -To use a relevant metaphor, technological knowledge is the quality of society's textbooks, whereas human capital is the amount of time that the population has spent reading them. -Workers' productivity depends on both.

Describe diluting capital stock in relation to population growth:

-According to these theories, high population growth reduces GDP per worker because rapid growth in the number of workers forces the capital stock to be spread more thinly. In other words, when population growth is rapid, each worker is equipped with less capital. A smaller quantity of capital per worker leads to lower productivity and lower GDP per worker. -This problem is most apparent in the case of human capital. Countries with high population growth have large numbers of school-age children. This places a larger burden on the educational system. It is not surprising, therefore, that educational attainment tends to be low in countries with high population growth. -The differences in population growth around the world are large. In developed countries, such as the United States and those in Western Europe, the population has risen only about 1 percent per year in recent decades and is expected to rise even more slowly in the future. By contrast, in many poor African countries, population grows at about 3 percent per year. At this rate, the population doubles every 23 years. This rapid population growth makes it harder to provide workers with the tools and skills they need to achieve high levels of productivity. -Rapid population growth is not the main reason that less developed countries are poor, but some analysts believe that reducing the rate of population growth would help these countries raise their standards of living. In some countries, this goal is accomplished directly with laws that regulate the number of children families may have. For example, from 1980 to 2015, China allowed only one child per family; couples who violated this rule were subject to substantial fines. In countries with greater freedom, the goal of reduced population growth is accomplished less directly by increasing awareness of birth control techniques.

Describe population growth:

-Economists and other social scientists have long debated how population affects a society. The most direct effect is on the size of the labor force: A large population means there are more workers to produce goods and services. The tremendous size of the Chinese population is one reason China is such an important player in the world economy. -At the same time, however, a large population means there are more people to consume those goods and services. So while a large population means a larger total output of goods and services, it need not mean a higher standard of living for the typical citizen. Indeed, both large and small nations are found at all levels of economic development. -Beyond these obvious effects of population size, population growth interacts with the other factors of production in ways that are more subtle and open to debate.

Describe education:

-Education—investment in human capital—is at least as important as investment in physical capital for a country's long-run economic success. In the United States, each year of schooling has historically raised a person's wage by an average of about 10 percent. In less developed countries, where human capital is especially scarce, the gap between the wages of educated and uneducated workers is even larger. -Some economists have argued that human capital is particularly important for economic growth because human capital confers positive externalities. An externality is the effect of one person's actions on the well-being of a bystander. An educated person, for instance, might generate new ideas about how best to produce goods and services. If these ideas enter society's pool of knowledge so that everyone can use them, then the ideas are an external benefit of education. In this case, the return from schooling for society is even greater than the return for the individual. This argument would justify the large subsidies to human-capital investment that we observe in the form of public education. -One problem facing some poor countries is the brain drain—the emigration of many of the most highly educated workers to rich countries, where these workers can enjoy a higher standard of living. If human capital does have positive externalities, then this brain drain makes those people left behind even poorer. This problem offers policymakers a dilemma.

Describe property rights and political stability:

-Production in market economies arises from the interactions of millions of individuals and firms. -This division of production among many firms allows the economy's factors of production to be used as effectively as possible. To achieve this outcome, the economy has to coordinate transactions among these firms, as well as between firms and consumers. Market economies achieve this coordination through market prices. That is, market prices are the instrument with which the invisible hand of the marketplace brings supply and demand into balance in each of the many thousands of markets that make up the economy. -One threat to property rights is political instability. When revolutions and coups are common, there is doubt about whether property rights will be respected in the future. If a revolutionary government might confiscate the capital of some businesses, as was often true after communist revolutions, domestic residents have less incentive to save, invest, and start new businesses. At the same time, foreigners have less incentive to invest in the country. Even the threat of revolution can act to depress a nation's standard of living. -Thus, economic prosperity depends in part on favorable political institutions. A country with an efficient court system, honest government officials, and a stable constitution will enjoy a higher standard of living than a country with a poor court system, corrupt officials, and frequent revolutions and coups.

Describe research and development:

-The primary reason that living standards are higher today than they were a century ago is that technological knowledge has advanced. The telephone, the transistor, the computer, and the internal combustion engine are among the thousands of innovations that have improved the ability to produce goods and services. -Yet another way in which government policy encourages research is through the patent system. When a person or firm creates an innovative product, such as a new drug, the inventor can apply for a patent. If the product is deemed truly original, the government awards the patent, which gives the inventor the exclusive right to make the product for a specified number of years. In essence, the patent gives the inventor a property right over her invention, turning her new idea from a public good into a private good. By allowing inventors to profit from their inventions—even if only temporarily—the patent system increases the incentive for individuals and firms to engage in research.

Describe health and nutrition

-human capital usually refers to education, but it can also be used to describe another type of investment in people: expenditures that lead to a healthier population. Other things being equal, healthier workers are more productive. The right investments in the health of the population provide one way for a nation to increase productivity and raise living standards. -Moreover, studies have found that height is an indicator of productivity. Looking at data on a large number of workers at a point in time, researchers have found that taller workers tend to earn more. Because wages reflect a worker's productivity, this finding suggests that taller workers tend to be more productive. The effect of height on wages is especially pronounced in poorer countries, where malnutrition is a bigger risk. -The causal link between health and wealth runs in both directions. Poor countries are poor in part because their populations are not healthy, and their populations are not healthy in part because they are poor and cannot afford adequate healthcare and nutrition. It is a vicious circle. But this fact opens the possibility of a virtuous circle: Policies that lead to more rapid economic growth would naturally improve health outcomes, which in turn would further promote economic growth.

Describe what the data on real GDP per person shows:

-living standards vary widely from country to country. -Income per person in the United States, for instance, is now almost four times that in China and about eight times that in India. -The poorest countries have average levels of income not seen in the developed world for many decades. -These data show that the world's richest countries are not guaranteed to remain the richest and that the world's poorest countries are not doomed to endless poverty.

Foreign direct investment

A capital investment that is owned and operated by a foreign entity

Describe promoting technological progress in population growth

Rapid population growth may depress economic prosperity by reducing the amount of capital each worker has, but it may also have some benefits. Some economists have suggested that world population growth has been an engine of technological progress and economic prosperity. The mechanism is simple: If there are more people, then there are more scientists, inventors, and engineers to contribute to technological advance, which benefits everyone.

catch up effect

the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich -In poor countries, workers lack even the most rudimentary tools and, as a result, have low productivity. Thus, small amounts of capital investment can substantially raise these workers' productivity. By contrast, workers in rich countries have high productivity partly because they have large amounts of capital with which to work. When the amount of capital per worker is already so high, additional capital investment has a relatively small effect on productivity -This catch-up effect can help explain some otherwise puzzling facts. Here's an example: From 1960 to 1990, the United States and South Korea devoted a similar share of GDP to investment. Yet over this time, the United States experienced only moderate growth of about 2 percent, while South Korea experienced spectacular growth of more than 6 percent. The explanation is the catch-up

diminishing returns

the property whereby the benefit from an extra unit of an input declines as the quantity of the input increases -As the stock of capital rises, the extra output produced from an additional unit of capital falls. -Capital's diminishing returns is sometimes called the diminishing marginal product of capital. -As the higher saving rate allows more capital to be accumulated, the benefits from additional capital become smaller over time, and so growth slows down. -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 -The property of diminishing returns to capital has another important implication: Other things being equal, it is easier for a country to grow fast if it starts out relatively poor. (sometimes called catch-up effect)

True or false? GDP can measure these two things simultaneously because, for the economy as a whole, they must be equal. Put simply, an economy's income is the economy's output.

true

True or false? Over the past century, real GDP per person in the US has grown about 2% per year, meaning it has roughly doubled every 35 years

true

What does an economy's GDP measure?

two things at once: the total income earned by everyone in the economy and the total expenditure on the economy's output of goods and services.