Macro 10: Economic Growth

Constant returns to scale

the situation when all inputs are increased by some proportion and output increases by the same proportion.

9. This figure shows three different production functions. Using the diagram of the production function, answer the following questions.

(i) If the economy experiences technological innovation, this can be represented by the movement from point(s) _____ to point(s) _____. (ii) If the economy experiences a decrease in capital stock, this can be represented by the movement from point(s) _____ to point(s) _____. (iii) If the economy experiences an increase in capital stock, this can be represented by the movement from point(s) _____ to point(s) _____. ANSWER: (i) E to C, or C to A; (ii) D to C, or C to B; (iii) B to C, or C to D

The Role of Incentives

1. Property rights grant control over a tangible or intangible resource. Without property rights, there is no incentive to create wealth. 2. A stable government makes economic growth more likely. Corruption and political instability discourage investment and innovation. 3. Efficient regulation: Bureaucratic obstacles, including excessive regulatory oversight, can hinder economic growth. Government strategies to encourage innovation include the following: 1. Create incentives through intellectual property laws. 2. Subsidize research and development.

The government changes the minimum working age to 21. Which inputs into the production function changed? A. Labor B. human capital C. physical capital

A. Labor

6. How does the Solow growth model present a solution to breaking the cycle of poverty?

ANSWER: The Solow growth model shows that economic growth occurs due to human capital, physical capital accumulation, and labor. However, these factors alone do not lead to continuous economic growth. Technological advancement that shifts production functions upward can lead to continuous and sustained economic growth and thus break the cycle of poverty

7. What are the components of an aggregate production function, and what does the production function show about how to achieve economic growth?

ANSWER: The aggregate production function is Y = f(L, H, K), where Y is GDP, L is labor, H is human capital, and K is physical capital. The production function shows us that economic growth occurs through the increased employment of labor, the enhancement of human capital, increases in physical capital, and the development of more efficient methods to transform inputs into outputs (technological advancement).

The government mandates that community college education be tuition free. Which inputs into the production function changed? A. Labor B. human capital C. physical capital

B. Human capital

The government provides a tax-free period for firms to purchase computers and tablets for employees. Which inputs into the production function changed? A. Labor B. human capital C. physical capital

C. Physical capital

Ingredients of The Aggregate Production Function

Ingredient One: Labor and Total Hours Worked - Some demographic factors can inhibit/enhance economic growth[The dependency ratio is the number of people too young or too old to work per 100 people of working age;Women entered the labor force in large numbers during WWII.] Ingredient Two: Human Capital Labor productivity is the quantity of goods and services that each person produces per hour of work. Ingredient Three: Capital Accumulation Capital stock is the total quantity of physical capital used in the production of goods and services. New Recipe for Combining Ingredients: Technological Progress

The Aggregate Production Function

The aggregate production function relates total output (GDP) to the quantity of inputs employed. Human capital: Skills that workers bring to the job Physical capital: Tools, machinery, and structures A country will produce more output if 1. it employs more workers. 2. its workers become more highly skilled. 3. it accumulates more physical capital. Improving the recipe can also lead to more output.

The Production Function

The production function describes the methods by which inputs are transformed into outputs.

The law of diminishing returns

when one input is held constant, increases in the other inputs will, at some point, begin to yield smaller and smaller increases in output. Diminishing returns implies poor countries can catch-up to wealthier ones. Investment in capital will have a large return for a relatively poor country.

Why does economic growth matter?

▪ Before modern civilization, there was little to no economic growth. ▪ Each generation lived exactly the same as its ancestors, largely hand-to-mouth. ▪ With advancements in agriculture, fewer people needed to work on farms. ▪ This led to the Industrial Revolution, which resulted in levels of economic growth never before experienced. ▪ Small differences in economic growth amplify over time, resulting in "rich" countries.

The Solow Model

▪ The capital stock will grow as long as investment outpaces depreciation. ▪ Capital per worker (K/L) will eventually stop growing. Capital accumulation can't sustain long-term economic growth. The Solow model shows that investment in capital can led to economic growth but that the economy eventually enters into a steady state.

Impact of Technological Progress

▪ The key to sustained economic growth is technology. ▪ Technology shifts the production function. ▪ The shift yields more output for a given capitallabor ratio. ▪ Sustainable economic growth is driven by new ideas.