Innovation and Economic Growth Quiz

Innovation and Economic Growth

• Economic output comes from combining factors of production: labor, capital, natural resources, entrepreneurship.
• Economic growth happens by increasing inputs or finding ways to get more output with the same inputs.
• Innovation is crucial for increasing output per input, leading to continuous prosperity. Adding more inputs eventually yields diminishing returns.
• Innovation overcomes these limitations.

The Malthusian Trap

• Thomas Malthus proposed a theory explaining population patterns and living standards.
• The world has a limited carrying capacity, meaning food production is constrained.
• Scarce food limits population growth.
• The economy was once seen as a zero-sum game; an increase in population meant lower incomes, and vice versa.

The Black Death Case Study

• The Black Death (mid-1300s) significantly reduced the English population.
• This population drop led to increased income per capita (a 30% increase).
• More available land per person and better land usage led to higher output per capita.
• Subsequent population growth gradually reduced income gains.

Innovation in the Malthusian Economy

• Even within the Malthusian era, some innovations (e.g., iron plows, horse collars) increased productivity.
• However, these innovations led to increased population, negating the temporary rise in prosperity.
• Land productivity correlates with population density, but not with income per capita.

The End of the Malthusian Trap

• The Industrial Revolution marked a significant shift from a Malthusian economy.
• Significant improvements in living standards occurred in Western Europe and North America.
• The rest of the world remained relatively poor.

Why Innovation Matters

• Increased innovation leads to faster output growth.
• Faster output growth than population growth leads to better living standards.
• The 19th-century shift to positive-sum economic growth.

Factors Driving Increased Innovation

• Cultural factors – potential effects of European cultural characteristics.
• Resources and disease resistance.
• Societal views on markets.
• Institutional factors - "economic freedom" arguments.

Production Functions and Inputs

• Production functions show the relationship between inputs and output.
• Examples: bakeries using labor, resources (ingredients), and capital (equipment).

Diminishing Marginal Product

• Adding more inputs doesn't always yield the same increase in output.
• Marginal product of an input declines as the quantity of that input increases (all else equal).

Examples of Diminishing Marginal Product

• Diminishing marginal product of labor— adding bakers with fixed equipment leads to successively smaller increases in cookie output.
• Diminishing marginal product of capital— adding ovens with a fixed number of bakers leads to successively smaller increases in cookie output.

Innovation and Productivity

• Process innovation: improving the way things are made (e.g., division of labor in a bakery).
• Product innovation: introducing new goods or services (e.g., KitchenAid).
• Both increase productivity and output per input.

Creative Destruction

• Innovation leads to a constant evolution of the market economy.
• Productivity increases, freeing up resources for other uses.
• This is exemplified in agriculture (tractors, fertilizers).