ECON 101 - Chapter 7

1. The average quantity of g&s produced per unit of labor input.

• 2. Y = real GDP = quantity of output produced
• L = quantity of labor
• so we can write productivity as Y/L (output per worker)

• 1. Physical Capital per Worker
• K/L

• 2. Human Capital per Worker
• H/L

• 3. Natural Resources per Worker
• N/L

4. Technological Change

Productivity is higher when the average worker has access to more capital (machines, equipment, etc.)

Therefore, an increase in K/L causes an increase in Y/L

Human capital (H): the knowledge and skills workers acquire through education, training, and experience

H/L = the average worker’s human capital

Productivity is higher when the average worker has more human capital (education, skills, etc.).

i.e., an increase in H/L causes an increase in Y/L.

1. Better machinery and equipment

2. Increases in human capital (H)

3. Better means of organizing and managing production

1. A model that explains growth rates in real GDP per capita over the long run. 

2. Solow growth model

1. A graph that shows the relationship between capital per hour worked and real GDP per hour worked, holding technology constant.

2. Increases in capital per hour worked increase output per hour worked but at a diminishing rate. For example, an increase in capital per hour worked from $20,000 to $30,000 increases real GDP per hour worked from $200 to $350 whereas an increase in capital per hour worked from $30,000 to $40,000 increases real GDP per hour worked only from $350 to $475.

Each additional $10,000 increase in capital per hour worked results in a progressively smaller increase in output per hour worked.

As K rises, the extra output from an additional unit of K falls

If workers have little K, giving them more increases their productivity a lot.

If workers already have a lot of K, giving them more increases productivity fairly little.

1. The property whereby poor countries tend to grow more rapidly than rich ones

• 2. The catch-up effect
• * In order for the catch-up effect to work, it must be true that both countries have the same technology and hence production function.  If the poor country has inferior technology, its production function will be lower; then, it won’t necessarily grow faster than the rich one, and the gap won’t necessarily shrink over time. 

Technological change shifts up the production function and allows more output per hour worked with the same amount of capital per hour worked.

In the long run due to diminishing returns to capital, a country will experience an increasing standard of living only if it experiences continuing technological change

1. A model of long-run economic growth that  and so is determined by the working of the market system.

2. Paul Romer

3. The theory argues that while the accumulation of knowledge capital is subject to diminishing returns at the firm level, it is subject to increasing returns at the level of the entire economy once knowledge becomes available to everyone.

The use of knowledge capital is nonrival because one firm’s using that knowledge does not prevent another firm from using it, and it is nonexcludable because once something becomes known, it becomes widely available for other firms to use (unless the government gives a firm the legal right to exclusive use).

* Thus, firms can freeride on the research and development of other firms by benefiting from results they didn't pay for

Romer points out that firms are unlikely to invest in research and development up to the point where the marginal cost of the research equals the marginal return from the knowledge gained because other firms gain much of the marginal return, resulting in an inefficiently small amount of research and development that slows the accumulation of knowledge capital and economic growth.

1. Patents and copyrights  The exclusive right to produce a product for a period of 20 years from the date the patent is applied for.

Just as a new product or a new method of making a product receives patent protection, books, films, and other artistic works receive copyright protection.

2. Subsidizing research and development. The government uses subsidies to increase the quantity of research and development that takes place and provides tax benefits to firms that invest in it.

3. Subsidizing education. By subsidizing education, the government increases the number of workers who have technical training and higher learning.

Schumpeter developed a model of growth emphasizing his view that new products unleash a “gale of creative destruction” that drives older products—and, often, the firms that produced them—out of the market.

According to Schumpeter, the key to rising living standards is not small changes to existing products but, rather, new products that meet consumer wants in qualitatively better ways.

To Schumpeter, the entrepreneur is central to economic growth.

The profits an entrepreneur hopes to earn provide the incentive for bringing together the factors of production—labour, capital, and natural resources—to start new firms and introduce new goods and services.

Successful entrepreneurs are better able to attract funds from investors.

• 1. Foreign direct investment (FDI)  
• The purchase or building by a corporation of a facility in a foreign country. The purchase or building by a corporation of a facility in a foreign country.

2. Foreign portfolio investment  The purchase by an individual or a firm of stocks or bonds issued in another country.

3. Globalization  The process of countries becoming more open to foreign trade and investment.

Foreign direct investment and foreign portfolio investment can give a low-income country access to funds and technology that otherwise would not be available.