Transcript My lecture

Mankiw: Brief Principles of
Macroeconomics, Second Edition
(Harcourt, 2001)
Ch. 7: Production and Growth
Income Differences
• Per capita income around the world varies
vastly.
– US per capita income in
– per capita income in
• Within each country, there are vast
differences between the earnings of the poor
and the rich. Average income does not say
anything about distribution.
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Dr. Ugur Aker
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Per Capita Incomes
According to the World Bank, the
Per capita incomes for selected
countries in 1999 were as given.
Instead of using the existing
exchange rate between USD and
the country’s currency, the World
Bank uses the prices within the
countries to better gauge the
standard of living. Purchasing
Power Parity means that.
Source:
http://www.worldbank.org/data/databytopic/GNPPC.pdf
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Why Do Per Capita Incomes Differ?
• The short answer is “productivity.”
– Productivity is amount of goods and services
produced by a typical (average) worker.
– Calculated by the ratio of GDP to total hours
worked.
– Increase in population may or may not increase
productivity.
• If the newcomers produce at the level of average worker,
per capita income stays the same.
• If the newcomers produce at a lower level than the
average worker, per capita income drops.
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Dr. Ugur Aker
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Why Do Per Capita Incomes Differ?
• The faster the productivity growth, the
faster will GDP rise.
• Per capita income may not rise even with
increasing productivity.
– If population growth is faster than GDP growth,
per capita income falls.
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Dr. Ugur Aker
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Doubling Standard of Living
• Even small increases in per capita income
per year, if sustained for a long period, can
improve standard of living tremendously.
• How long does it take to double per capita
income?
– If per capita GDP growth is 1%?
– If per capita GDP growth is 2%?
– If per capita GDP growth is 3.5%?
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Growth in Selected Countries
Source: http://www.worldbank.org/data/wdi2000/pdfs/tab4_1.pdf
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What Determines Productivity?
• Physical Capital: total amount of equipment,
tools, machines, buildings in a country.
• Human Capital: total amount of knowledge,
skills people of a country has.
• Natural Resources: the amount of arable land,
water resources, minerals, oil, etc.
• Technology: how goods and services are
produced. An increase in output without
increasing inputs is a technological
improvement.
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Some Questions
• Is it possible to have a very technologically
advanced nation with a low human capital?
– When students don’t learn what is in their textbooks.
• Which is better?
– Technology or human capital?
– Natural resources or physical capital?
– Human capital or physical capital?
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Formal Presentation of Productivity
Y = A f(L,K,H,N)
If production function has constant returns to scale,
doubling inputs will double output.
2Y = A f(2L, 2K, 2H, 2N) or
xY = A f(xL, xK, xH, xN)
Suppose x=(1/L)
(Y/L) = A f(1, K/L, H/L, N/L)
Productivity, (Y/L), therefore, depends on increases of
physical capital per worker, human capital per worker,
and natural resources per worker.
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Growth and Environment
• What happens when we run out of oil?
• Some analogies
– 17th century England: what happens when we run
out of land?
– 19th century: what happens when we run out of
coal?
– 20th century: what happens when we run out of tin
and copper?
• Prices of goods that become relatively scarce
rise.
– Incentives to find alternative sources.
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Growth and Environment
• What if prices of natural resources do not
rise because of market failure?
– The costs of production or usage do not reflect
the costs imposed to third parties.
– Global warming, acid rain.
• Political and economic power allows some
populations to impose their costs on others
that are weaker.
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How Can We Improve Well Being?
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Saving and Investment
Catching up of poorer countries
Diminishing returns on growth
Foreign Investment
Education
Property Rights
Political Stability
Free Trade
Population Growth
Research and Development
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Trade-off Between Consumption and
Saving
Consumption Goods Capital Goods
0
30
40
25
75
20
105
15
130
10
150
5
165
0
Capital Goods
Production Possibilities Frontier
30
20
10
0
0
50
100
Consumption Goods
150
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Dr. Ugur Aker
The more a society devotes
its resources to consumption,
the less will be available for
saving and capital formation
(investment). The more a
society devotes resources to
investment today, the more it
can produce next year
because the PPF would shift
farther out.
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Investment and Growth
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Diminishing Returns
• As capital increases, the additional output from
an additional unit of capital will eventually be
diminishing.
• Traditionally, this has been observed with
roads, railroads, and other kinds of capital
increases.
• When diminishing returns set in, growth may
slow down.
• New economy theories discard this assumption.
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Catch-up Effect
• Societies starting from a lower level of per
capita income, capital and technology may
grow faster than the historical rates for
wealthy societies because they can adopt
the newer and tried technology right away.
• Diminishing returns and catch-up effect can
explain why rich societies have low growth
rates while poorer societies, with the same
investment percentage, have higher growth
rates.
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Investment From Abroad
• Foreign Direct Investment
– Foreign nationals establish firms, plants to produce
in your country.
• Foreign Portfolio Investment
– Foreign nationals buy stocks and bonds or put their
money in the banks of your country.
• Both forms increase the investment in your
country.
– Foreign direct investment by increasing the
buildings, machines, tools, equipment directly.
– Foreign portfolio investment by providing funds for
local businesses to expand their operations.
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Investment from Abroad
• The output created by the extra investment
from abroad raises the GDP of the country.
• When profits are repatriated to the country
of origin, the receiving country’s GNP is
reduced by that amount.
• GDP is output produced in US.
• GNP is output produced by American
residents.
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Education
• Investment in human capital is more important
than investment in physical capital.
– If there is no one who can run or fix the machines,
what good are they?
• In poor countries, elementary education
contributes to future income many times the
initial investment.
• The more educated a population is the easier it
can adjust to technological change.
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Education and Positive Externalities
• Educated people might generate more new
ideas that become part of the knowledge of
the society.
• The more educated a society, the lower
violent crimes may be. That increases the
security of the rest of the population and
saves them from spending time, effort and
income on security.
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Property Rights and Political Stability
• Productivity of individuals fall when they do not expect
to reap the benefits of their own efforts.
• Well defined and court protected property rights and
contract enforcement allow the market system work
efficiently where many different specialized activities
produce and distribute goods and services.
• Lack of property rights encourages people to produce
for their own consumption.
• Lack of property rights discourages savings and also
foreign investment.
• Political instability undermines property rights.
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Dr. Ugur Aker
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Free Trade
• Engaging in trade raises the average standard of
living; it is similar to technological advance.
• Newly independent countries in the fifties,
sixties and seventies pursued a self-sufficiency
policy and enacted high tariffs to discourage
imports.
• These inward oriented policies slowed their
growth, created incentives for corruption.
• The success of outward oriented countries
during this time convinced many countries in the
eighties and nineties to move toward free trade.
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Population Growth
• High population growth reduces K/L, H/L and N/L.
• High population growth creates a large percentage of
school age children, requiring resources diverted toward
education.
• Population growth was controlled through western birth
control methods in India without much success.
• China has been more successful with severe
disincentives for more children.
• Urbanization, education of women seem to influence
population growth more than birth control education.
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Dr. Ugur Aker
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Research and Development
• Knowledge is a public good - once it is
available, one person’s use of it doesn’t reduce
another person’s use.
• Public goods are not privately produced unless
they can be made private.
– Patents, copyrights, intellectual property rights laws
are efforts to make a public good private.
• Governments can provide public goods through
taxes.
• Government support of research and
development can improve technology.
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