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# Chapter 3. Production and Growth ## 3-1 Economic Growth Around the World - **Living standards**, as measured by real GDP per person, vary significantly across countries. - The **growth rates** of living standards also vary substantially. - Because of **compounding**, small differences in growth...

# Chapter 3. Production and Growth ## 3-1 Economic Growth Around the World - **Living standards**, as measured by real GDP per person, vary significantly across countries. - The **growth rates** of living standards also vary substantially. - Because of **compounding**, small differences in growth rates can lead to large differences in living standards over time. ### Table 3-1. GDP per Person and Its Growth | Country | GDP per Person in 2019 | Average Growth Rate 1960-2019 | | -------------- | ----------------------- | ----------------------------- | | United States | $65,298 | 2.0% | | Japan | $41,466 | 2.9% | | China | $10,261 | 8.0% | | India | $2,100 | 4.2% | ## 3-2 Productivity: Its Role and Determinants - **Productivity** refers to the quantity of goods and services a worker can produce per unit of time. - Productivity plays a key role in determining living standards for all nations around the world. ### 3-2a Why Productivity Is So Important - Productivity is the main determinant of a country's living standards. - Growth in productivity is the main determinant of growth in living standards. - **Diminishing returns** and the **catch-up effect** mean that it is easier for poor countries to grow faster than rich ones. ### 3-2b How Productivity Is Determined - **Physical Capital:** the stock of equipment and structures that are used to produce goods and services - **Human Capital:** the knowledge and skills that workers acquire through education, training, and experience - **Natural Resources:** the inputs into production that are provided by nature, such as land, rivers, and mineral deposits - **Technological Knowledge:** society's understanding of the best ways to produce goods and services #### FYI: Are Natural Resources a Limit to Growth? - Some argue that population growth is depleting the world's finite supply of natural resources, and thus will limit growth in living standards. - But technological progress often yields ways to circumvent these limits. - Hybrid cars use less gas. - More efficient irrigation methods help conserve water. - As a resource becomes scarcer, its market price rises, which provides incentive to conserve it and develop alternatives. ## 3-3 Economic Growth and Public Policy ### 3-3a Saving and Investment - One way to raise future productivity is to invest more current resources in the production of capital. - We can increase $K$ by encouraging saving and investment. - Policies: - Evaluate how policies affect saving & investment. - Enact policies that raise saving & investment. ### 3-3b Diminishing Returns and the Catch-Up Effect - **Diminishing Returns:** As $K$ rises, the extra output from an additional unit of $K$ falls. - **Catch-Up Effect:** Poor countries tend to grow more rapidly than rich ones. ### 3-3c Investment from Abroad - To raise $K$ and hence productivity, growth, the government can also encourage - **Foreign Direct Investment:** Capital investment that is owned and operated by a foreign entity - **Foreign Portfolio Investment:** Investments financed with foreign money but operated by domestic residents ### 3-3d Education - Education - investment in human capital ($H$) has similar effects as investment in physical capital ($K$): - Policies to improve education: - public schools - subsidized loans for college - Education has significant effects: In the U.S., each year of schooling raises a worker's wage by 10%. ### 3-3e Health and Nutrition - Health care expenditure is also a type of investment in human capital. - Malnutrition reduces productivity. - In poor countries, better nutrition raises worker productivity: - During 1962-1995, height of Koreans increased 6 cm (2.4 in). As a result, South Korea's economic growth rate exceeded that of North Korea. ### 3-3f Property Rights and Political Stability - Markets are not a good way to allocate resources when property rights are not well established: - Political instability (e.g., frequent coups) creates uncertainty over whether property rights will be protected in the future. - Then, - Domestic residents have less incentive to save, invest, and start new businesses. - Foreigners have less incentive to invest here. - Result: lower living standards. ### 3-3g Free Trade - Trade can improve a country's productivity and living standards: - Allows each country to specialize in what it does best. - Allows countries to enjoy a greater variety of goods and services. ### 3-3h Research and Development - Technological progress is the main reason why living standards rise over the long run. - Knowledge is a *public good*: Ideas can be shared freely, increasing the productivity of many. - Policies to promote tech. knowledge: - Patent laws - Tax incentives or direct support for private sector R\&D - Grants for basic research at universities ### 3-3i Population Growth 1. Stretching natural resources - Malthus argued that population growth will strain society's ability to provide for itself; Mankind is doomed to forever live in poverty. - But Malthus neglected technological progress. 2. Diluting the capital stock - Bigger population means lower $K$ per worker; Lower productivity & living standards. - But, this effect is offset by policies that promote capital accumulation. 3. Promoting technological progress - More people = More scientists, inventors, engineers = More discoveries = Faster technological progress & economic growth. ## 3-4 Conclusion - Policies that promote growth: - Encourage saving & investment. - Encourage investment from abroad. - Promote education. - Improve health and nutrition. - Protect property rights and promote political stability. - Promote free trade - Promote research & development. - Be mindful of population growth. - These are not mutually exclusive policies. Indeed, they are often complementary.