Production Growth Chapter 22
What is the steady-state equilibrium?
The steady-state equilibrium is the point in a growing economy where investment spending is the same as spending on depreciation and the capital per worker remains constant.
How does the dilution of capital stock affect economic growth?
According to these theories, high population growth reduces GDP per worker because rapid growth in the number of workers forces capital stock to be spread more thinly. 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. For example countries with high population growth have large numbers of school-age children. This places a larger burden on the educational system.
How will an increase in the savings rate increase economic growth?
- An increase in the savings rate can increase investment and the capital per worker. -
What can governments do to raise productivity and living standards?
- Encouraging saving and investment. - Encouraging education and training. - Establishing secure property rights and maintaining political stability.
What is the importance of saving and investment?
- Investment is necessary to sustain and increase the capital stock. One way to raise future productivity is to invest more current resources in the production of capital. - Trade-off: given that resources are scarce, devoting more resources to producing capital requires fewer resources to produce goods and services for current consumption. - For a society to invest more in capital, it must consume less and save more of its current income. - Countries that devote a large share of GDP to investment tend to have high growth rates.
What does the Solow model show about the transition of economies over time?
- Less developed economies will have lower levels of capital per worker. - Investment in capital will increase the capital per worker and lead to growth. - However, investment is determined by the savings ratio. In less developed countries this may be relatively low because incomes are low and for those on low incomes, the priority is likely to be more on feeding the family and surviving rather than saving. - In addition, less developed countries may not have sufficiently developed financial institutions to promote savings.
The growth theory?
- Over time economic growth in most countries varies. - Over a period of time a trend can be established which is expressed as a growth rate in percentage terms. - The real GDP growth rate is given by: Growth rate of GDP in year t = GDPt - GDPt-1/ GDPt-1 x 100 In order for a county to experience considerable improvements in living standards, sustained growth over a period of time is necessary.
What does GDP show with regards to growth?
An economy's GDP measures both the total income earned in the economy and the total expenditure on the economy's output of goods and services. The level of growth of real GDP is one gauge of economic prosperity. Real GDP per capita = Real GDP/Total Population Real GDP per worker= Real GDP/Number of people in employment
How does diminishing returns affect growth?
As the stock of capital rises, the extra output produced from an additional unit of capital falls -> this property is called diminishing returns. Because of diminishing returns, an increase in the saving rate leads to higher growth only for a while. 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.
How does an increase in technology affect economic growth?
Assuming that the technology is not protected, and even if it is this tends to be for a limited time, it is freely available to everyone to exploit. The aggregate production function shows that even if capital and labour remain constant, an increase in technology will increase income because both capital and labour become more productive. Technology can offset the effects of diminishing marginal product and lead to proportional increases in productive capacity.
What is the Endogenous growth theory?
Endogenous growth theory is a theory of long-run economic growth which results from the creation of new knowledge and technology which impacts on everyone and makes them more productive as a result. An important element of changes in technology is innovation and investment by firms into R&D -> firms expect to gain a competitive advantage (profit motive).
Why is education important to economic growth?
For a country's long-run growth, education (investment in human capital) is at least as important as investment in physical capital. Thus, one way the government can enhance the standard of living is to provide schools and encourage the population to take advantage of them. An educated person might generate new ideas about how best to produce goods and services, which in turn, might enter society's pool of knowledge and provide an external benefit to others -> this is a positive externality. One problem facing some poor countries is the brain drain: the emigration of many of the most highly educated workers to rich countries.
Next two factors of production
Natural resources are inputs into production that are provided by nature, such as land, rivers and mineral deposits. Differences in natural resources are responsible for some of the differences in standards of living around the world -> the historical success of the US was driven in part by the large supply of land well suited for agriculture. Technological knowledge is the society's the understanding of the best ways to produce goods and services. Technical progress means that the quality of physical and human capital is improved so for any given quantity of capital and labour, the average productivity of both is higher, meaning that a higher output can be produced from the economy's factors of production.
What are the first two factors of production?
Physical capital makes workers more productive. The stock of equipment and structures that are used to produce goods and service is called physical capital. For example, a carpenter with only basic hand tools (e.g., saw) can make less furniture each week than a carpenter with more sophisticated and specialized woodworking equipment (e.g., electric circular saw). Human capital is the knowledge and skills that workers acquire through education, training and experience. Human capital includes the skills accumulated in early childhood programmes, primary school, secondary school, university or college, the on-the-job training for adults in the labour force. Like physical capital, human capital raises a nation ability to produce goods and services.
Why is productivity a key determinant of economic growth?
Productivity refers to the amount of goods and services that a worker can produce from each hour of work. Productivity plays a key role in determining living standards for all nations in the world. A nation can enjoy a high standard of living if it can produce a large quantity of goods and services. Western Europeans live better than Malians because western European workers are more productive than Malian workers.
Importance of property rights?
Property rights refer to the ability of people to exercise authority over the resources they own. An economy-wide respect for property rights is an important prerequisite for the price system to work. For example: a mining company will not make the effort to mine iron ore if it expects the ore to be stolen. It is necessary for investors to feel that their investments are secure. The system of justice enforces property rights
Who is Robert Solow and what is he famous for?
Robert Solow developed the neo-classical theory of economic growth and Solow won the Nobel Prize in Economics in 1987. He has made a huge contribution to our understanding of the factors that determine the rate of economic growth for different countries.
How does population affect economic growth?
The Solow growth model shows that if the labour force is rising, then in order for the capital per worker to remain constant, investment must cover depreciation and provide more capital. If investment does not keep pace with the rise in the population, people will become poorer. In part, this helps to explain why many less developed countries experience continued high levels of poverty because their population rises but investment fails to keep pace.
What are the basic points about the Solow Economic Growth Model?
The Solow model believes that a sustained rise in capital investment increases the growth rate only temporarily: because the ratio of capital to labour goes up. However, the marginal product of additional units of capital may decline (there are diminishing returns) and thus an economy moves back to a long-term growth path, with real GDP growing at the same rate as the growth of the workforce plus a factor to reflect improving productivity. A 'steady-state growth path' is reached when output, capital and labour are all growing at the same rate, so output per worker and capital per worker are constant. Neo-classical economists believe that to raise the trend rate of growth requires an increase in the labour supply + a higher level of productivity of labour and capital. Differences in the pace of technological change between countries are said to explain much of the variation in growth rates that we see.
What is the catch-up effect?
The catch-up effect refers to the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich. This helps explain why, over the past 40 years, China had a higher growth rate than Japan even though both countries devoted a similar share of GDP to investment.