Production and Growth - Chapter 7 - Textbook PDF

PRODUCTION AND GROWTH Chapter 7 Copyright © 2020 by Nelson Education Ltd. 7-1  PRODUCTION AND GROWTH ▪ The average person in a rich country, such as Canada, the United States, or Germany, has an income more than ten times as high as the average person in a poor country....

PRODUCTION AND GROWTH Chapter 7 Copyright © 2020 by Nelson Education Ltd. 7-1  PRODUCTION AND GROWTH ▪ The average person in a rich country, such as Canada, the United States, or Germany, has an income more than ten times as high as the average person in a poor country. Copyright © 2020 by Nelson Education Ltd. 7-2  PRODUCTION AND GROWTH ▪ In Canada over the past century, average income as measured by real GDP per person has grown by about 2 percent per year. ▪ This rate of growth implies that average income doubles every 35 years. ▪ Average income today is about eight times as high as average income a century ago. Copyright © 2020 by Nelson Education Ltd. 7-3  PRODUCTION AND GROWTH ▪ Growth rates vary substantially from country to country. ▪ From 2000 to 2014: ▪ GDP per person in China grew at a rate of 11 percent per year, accumulating to a 357 percent increase in average income. ▪ Income per person in Zimbabwe fell by a total of 13 percent. Copyright © 2020 by Nelson Education Ltd. 7-4  PRODUCTION AND GROWTH ▪ What explains the diversity in living standards and growth rates around the world? ▪ How can the rich countries ensure that they maintain their high standard of living? ▪ What policies should the poor countries pursue to promote more rapid growth in order to join the developed world? Copyright © 2020 by Nelson Education Ltd. 7-5 ECONOMIC GROWTH AROUND THE WORLD ▪ Data on real GDP per person show that living standards vary widely from country to country. ▪ Income per person in Canada is about: ▪ 3.5 times higher than that of China ▪ 11 times higher than that of India Copyright © 2020 by Nelson Education Ltd. 7-6 TABLE 7.1 The Variety of Growth Experiences Copyright © 2020 by Nelson Education Ltd. 7-7 PRODUCTIVITY: ITS ROLE AND DETERMINANTS ▪ Explaining the large variation in living standards around the world is very easy. PRODUCTIVITY ▪ Productivity: the quantity of goods and services produced from each hour of a worker’s time. Copyright © 2020 by Nelson Education Ltd. 7-8 PRODUCTIVITY: ITS ROLE AND DETERMINANTS WHY PRODUCTIVITY IS SO IMPORTANT ▪ Productivity is the key determinant of living standards. ▪ Growth in productivity is the key determinant of growth in living standards. ▪ For a country to enjoy a high standard of living, it must produce a large quantity of goods and services. Copyright © 2020 by Nelson Education Ltd. 7-9 PRODUCTIVITY: ITS ROLE AND DETERMINANTS HOW PRODUCTIVITY IS DETERMINED ▪ Determinants of productivity ▪ Physical capital per worker ▪ Human capital per worker ▪ Natural resources per worker ▪ Technological knowledge Copyright © 2020 by Nelson Education Ltd. 7-10 PRODUCTIVITY: ITS ROLE AND DETERMINANTS HOW PRODUCTIVITY IS DETERMINED (CONT’D) ▪ 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 the production of goods and services that are produced by nature, such as land, rivers, and mineral deposits. ▪ Technological knowledge: society’s understanding of the best ways to produce goods and services. Copyright © 2020 by Nelson Education Ltd. 7-11  ECONOMIC GROWTH AND PUBLIC POLICY ▪ The importance of saving and investment ▪ Diminishing returns and the catch-up effect ▪ Investment from abroad ▪ Education ▪ Health and nutrition ▪ Property rights and political stability ▪ Free trade ▪ Research and development ▪ Population growth Copyright © 2020 by Nelson Education Ltd. 7-12  ECONOMIC GROWTH AND PUBLIC POLICY THE IMPORTANCE OF SAVING, INVESTMENT, AND STABLE FINANCIAL MARKETS ▪ Because resources are scarce, devoting more resources to producing capital requires devoting fewer resources to producing goods and services for current consumption. ▪ Accumulating capital involves a tradeoff. Copyright © 2020 by Nelson Education Ltd. 7-13  ECONOMIC GROWTH AND PUBLIC POLICY THE IMPORTANCE OF SAVING, INVESTMENT, AND STABLE FINANCIAL MARKETS (CONT’D) ▪ When governments encourage saving and investment, they also encourage growth and in the long run this raises the standard of living. ▪ A well-functioning and carefully regulated financial market is a critical ingredient in the recipe for economic growth. Copyright © 2020 by Nelson Education Ltd. 7-14  ECONOMIC GROWTH AND PUBLIC POLICY DIMINISHING RETURNS AND THE CATCH-UP EFFECT ▪ Policies that raise the saving rate mean that fewer resources are needed to make consumption goods and more resources are now available to make capital goods. ▪ The capital stock increases, which raises productivity thus leading to a higher rate of growth of GDP. ▪ The benefits from additional capital become smaller over time, so growth slows down. Copyright © 2020 by Nelson Education Ltd. 7-15  ECONOMIC GROWTH AND PUBLIC POLICY DIMINISHING RETURNS AND THE CATCH-UP EFFECT (CONT’D) ▪ 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. This phenomenon is known as diminishing returns. ▪ Diminishing returns: the benefit from an extra unit of an input declines as the quantity of the input increases. Copyright © 2020 by Nelson Education Ltd. 7-16 FIGURE 7.1 Illustrating the Production Function Copyright © 2020 by Nelson Education Ltd. 7-17  ECONOMIC GROWTH AND PUBLIC POLICY DIMINISHING RETURNS AND THE CATCH-UP EFFECT (CONT’D) ▪ The diminishing returns to capital has another important implication: it is easier for a country to grow if it starts out relatively poor. ▪ Catch-up effect: countries that start off poor tend to grow more rapidly than countries that start off rich. Copyright © 2020 by Nelson Education Ltd. 7-18  ECONOMIC GROWTH AND PUBLIC POLICY INVESTMENT FROM ABROAD ▪ Investment by foreigners can also lead to new capital. ▪ Foreign direct investment: a capital investment that is owned and operated by a foreign entity. ▪ Foreign portfolio investment: an investment that is financed with foreign money but operated by domestic residents. Copyright © 2020 by Nelson Education Ltd. 7-19  ECONOMIC GROWTH AND PUBLIC POLICY EDUCATION ▪ Investment in human capital (education) is at least as important as investment in physical capital for long-run economic success. ▪ It is well known that more education leads to higher wages and salaries. ▪ One way government policy can improve the standard of living is to provide good schools. Copyright © 2020 by Nelson Education Ltd. 7-20  ECONOMIC GROWTH AND PUBLIC POLICY EDUCATION (CONT’D) ▪ Human capital is also important for economic growth because it conveys positive externalities. ▪ Externalities: the effect of one person’s actions on the well-being of a bystander. ▪ Some poor countries face a brain drain. ▪ Brain drain: the immigration of many of the most highly educated workers to rich countries, where they can enjoy a higher standard of living. Copyright © 2020 by Nelson Education Ltd. 7-21  ECONOMIC GROWTH AND PUBLIC POLICY HEALTH AND NUTRITION ▪ Other things equal, healthier workers are more productive. ▪ The causal link between health and wealth runs in both directions. ▪ Poor countries are poor in part because the populations are not healthy. Their populations are not healthy in part because they are poor. ▪ It is a vicious cycle. Copyright © 2020 by Nelson Education Ltd. 7-22  ECONOMIC GROWTH AND PUBLIC POLICY HEALTH AND NUTRITION (CONT’D) ▪ This opens the possibility of a virtuous cycle. ▪ Policies that lead to more rapid economic growth would naturally improve health outcomes. ▪ In turn, this would further promote economic growth. Copyright © 2020 by Nelson Education Ltd. 7-23  ECONOMIC GROWTH AND PUBLIC POLICY PROPERTY RIGHTS AND POLITICAL STABILITY ▪ In a free-market economy, it is the invisible hand that brings supply and demand into balance in the many thousands of markets. ▪ For the price system to work, property rights must be respected. ▪ Property rights: the ability of people to exercise authority over the resources they own. Copyright © 2020 by Nelson Education Ltd. 7-24  ECONOMIC GROWTH AND PUBLIC POLICY PROPERTY RIGHTS AND POLITICAL STABILITY (CONT’D) ▪ Political instability is a threat to property rights. ▪ Countries with an efficient court system, honest government officials, and a stable constitution will typically enjoy a higher standard of living. Copyright © 2020 by Nelson Education Ltd. 7-25  ECONOMIC GROWTH AND PUBLIC POLICY FREE TRADE ▪ Most economists today will say that a poor country is better off pursuing outward-oriented (as opposed to inward-oriented) policies that integrate these countries into the world economy. ▪ Countries that eliminate trade restrictions often experience the same kind of economic growth that would occur after a major technological advance. ▪ Trade volume is determined not only by government policy but also by geography. Copyright © 2020 by Nelson Education Ltd. 7-26  ECONOMIC GROWTH AND PUBLIC POLICY RESEARCH AND DEVELOPMENT ▪ One of the major reasons why living standards are so much higher today than they were a century ago is because state-of-the-art technological knowledge has progressed so much. ▪ Even if most R&D is conducted in the private sector, there is a public interest in promoting such efforts. ▪ Knowledge is a public good. ▪ Governments have a vested interest in promoting R&D. Copyright © 2020 by Nelson Education Ltd. 7-27  ECONOMIC GROWTH AND PUBLIC POLICY RESEARCH AND DEVELOPMENT (CONT’D) ▪ Over the years, the Canadian government has: ▪ Funded research in CANDU nuclear reactors. ▪ Offered research grants ▪ Offered tax breaks to firms that engage in R&D. ▪ Managed the patent system. Copyright © 2020 by Nelson Education Ltd. 7-28  ECONOMIC GROWTH AND PUBLIC POLICY POPULATION GROWTH ▪ A large population means a larger total output of goods and services. ▪ However, it need not mean a higher standard of living for a typical citizen. ▪ Beyond these obvious effects of population size, population growth interacts with the other factors of production in ways that are more subtle and open to debate. Copyright © 2020 by Nelson Education Ltd. 7-29  ECONOMIC GROWTH AND PUBLIC POLICY POPULATION GROWTH (CONT’D) ▪ Stretching natural resources ▪ A large population means a larger workforce. ▪ A large population means more consumers. ▪ A large population need not mean a higher standard of living. ▪ Thomas Robert Malthus (1766–1834) argued that an ever-increasing population would continually strain society’s ability to provide for itself. ▪ Mankind was doomed to forever live in poverty. Copyright © 2020 by Nelson Education Ltd. 7-30  ECONOMIC GROWTH AND PUBLIC POLICY POPULATION GROWTH (CONT’D) ▪ Diluting capital stock ▪ According to this theory, high population growth reduces GDP per worker because rapid growth in the number of workers forces the capital stock to be spread more thinly. ▪ A smaller quantity of capital per worker leads to lower productivity and lower GDP per worker. ▪ Some believe that reducing the rate of population growth would help poor countries raise their standards of living: ▪ By regulating the number of children (e.g., China). ▪ By policies that foster equal treatment of women. Copyright © 2020 by Nelson Education Ltd. 7-31  ECONOMIC GROWTH AND PUBLIC POLICY POPULATION GROWTH (CONT’D) ▪ Promoting technological progress ▪ Some economists believe that population growth has been an engine of technological progress and economic prosperity. ▪ More people means more scientists, more inventors, and more engineers. Copyright © 2020 by Nelson Education Ltd. 7-32  CONCLUSION: THE IMPORTANCE OF LONG-RUN GROWTH ▪ A country’s standard of living depends on its ability to produce goods and services. ▪ Policymakers who want to encourage growth in standards of living must aim to increase their nations’ productive ability. ▪ Economists differ in their views of the role of government in promoting economic growth. ▪ At the very least, government can lend support to the invisible hand by maintaining property rights and political stability. ▪ More controversial is whether government should target and subsidize specific industries that might be especially important for technological progress. Copyright © 2020 by Nelson Education Ltd. 7-33 THE END Copyright © 2020 by Nelson Education Ltd. 7-34