Macroeconomics A Contemporary Approach 10th Edition Mceachern Solutions Manual

Macroeconomics A Contemporary
Approach 10th Edition McEachern

Solutions Manual
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CHAPTER 8
PRODUCTIVITY AND GROWTH
INTRODUCTION
This chapter introduces productivity and growth as keys to economic prosperity, using the per-
worker production function as a framework. The productivity across nations is examined and the
U.S. growth record, particularly since World War II, is considered in detail. Given the importance of
productivity growth in determining a nation’s standard of living, this is an especially interesting and
relevant chapter.
CHAPTER OUTLINE
I. Theory of Productivity and Growth
A. Growth and the Production Possibilities Frontier (Slides 3-8)
Outward shift in the PPF caused by:
• greater availability of resources
• improvement in the quality of resources
• technological changes that make better use of resources
• improvements in the rules of the game that enhance production
B. What Is Productivity? (Slide 9)
Ratio of total output to a specific measure of input.
C. Labor Productivity: Output per unit of labor, measured as real GDP divided by the
hours of labor used to produce the output.
D. Per-Worker Production Function (Slides 12-14)
• Relationship between the amount of capital per worker and the output per
worker.
• Slope of the curve (per-worker production function): Positive because an
increase in capital per worker helps each worker produce more output. The
diminishing slope reflects the law of diminishing marginal returns from capital:
As the quantity of capital increases, the output per worker increases at a
diminishing rate.
• Capital deepening is an increase in the quantity of capital per worker.
E. Technological Change: Usually improves the quality of capital. As technological
breakthroughs become embodied in new capital, resources are combined more
efficiently, increasing total output.
F. Rules of the Game: the formal and informal institutions that promote economic
activity.
II. Productivity and Growth in Practice (Slides 18-20)

• The U.S. produces about 155 times the per capita output of the world’s poorest
countries
• Industrial market countries (economically advanced capitalist countries) versus
developing countries (lower standard of living due to less human and physical capital)
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
232 Chapter 8 Productivity and Growth
A. Education and Economic Development (Slides 21-22)

B. U.S. Labor Productivity
• Small differences in productivity can make huge differences in the
economy’s ability to produce and therefore, on the standard of living.
C. Slowdown and Rebound in Productivity Growth
Productivity growth in the U.S. rebounded from 1974-1982 and, from
1983-1995 averaged 1.8%. From 1996 to 2010, productivity growth
averaged 2.7%. The growth during this time is partly attributed to the
information revolution powered by the computer chip.
D. Output per Capita: (Slides 28-29)
Real GDP divided by population indicates how much an economy
produces on average per resident.
Output per capita increases if:
• Labor productivity increases for a given worker-population ratio
• Worker-population ratio increases for a given labor productivity
• Both worker-population ratio and labor productivity increase
E. International Comparisons: (Slides 30-32)
• U.S. is the top country, with a per capita income of 21% above second-
ranked Canada
• U.S. has average growth in output per capita of 1.8% per year, third
among seven major economies.
III. Other Issues of Technology and Growth
A. Does Technological Change Lead to Unemployment?(Slide 33)

• Some fear that if technological change reduces the labor needed to
produce a given amount of output, it can lead to unemployment in
some industries.
• But technological change can make products more affordable.
• Change may displace workers in short run, but long-term benefits
include higher real incomes and more leisure.
B. Research and Development (Slides 34-37)
Improvements in technology arise from scientific discovery.
• Basic Research: The search for knowledge without regard for how
that knowledge will be used?
• Applied Research: Seeks to answer particular questions or apply
scientific discoveries to the development of specific products.
• Expenditures for Research and Development: R&D spending as a
percentage of GDP
C. Industrial Policy: (Slides 38-40)
The idea that government—using taxes, subsidies, regulations, and
coordination of the private sector—can help nurture industries and
technologies of the future to give domestic industries an advantage over
foreign competitors..
CaseStudy: Income and Happiness (Slides 41-43)
Chapter 8 Productivity and Growth 233
CONCLUSION
Productivity and growth depend on the supply and quality of resources, the level of technology, and
the rules of the game that nurture production and exchange. We should distinguish between an
economy’s standard of living, as measured by output per capita, and improvements in that standard
of living, as measured by the growth in output per capita. In the long run, productivity growth and
the growth in workers relative to the growth in population will determine whether or not the United
States continues to enjoy one of the world’s highest standard of living.
CHAPTER SUMMARY
If the population is continually increasing, an economy must produce more goods and services
simply to maintain its standard of living, as measured by output per capita. If output grows faster
than the population, the standard of living rises.
An economy’s standard of living grows over the long run because of (a) increases in the amount and
quality of resources, especially labor and capital; (b) better technology; and (c) improvements in the
rules of the game that facilitate production and exchange, such as tax laws, property rights, patent
laws, the legal system, and customs of the market.
The per-worker production function shows the relationship between the amount of capital per worker
in the economy and the output per worker. As capital per worker increases, so does output per
worker, but at a decreasing rate. Technological change and improvements in the rules of the game
shift the per-worker production function upward, so more is produced for each ratio of capital per
worker.
Since 1870, U.S. labor productivity growth has averaged 2.1 percent per year. The quality of labor
and capital is much more important than the quantity of these resources. Labor productivity growth
slowed between 1974 and 1982, in part because of spikes in energy prices and implementation of
costly but necessary environmental and workplace regulations. Since 1983 productivity growth has
picked up, especially since 1996, due primarily to information technology.
Among the seven major industrial market economies, the United States has experienced the third
highest growth rate in real GDP per capita over the last quarter of a century and most recently
produced the highest real GDP per capita.
Technological change sometimes costs jobs and imposes hardships in the short run, as workers
scramble to adapt to a changing world. Over time, however, most displaced workers find other jobs,
sometimes in new industries created by technological change. There is no evidence that, in the long
run, technological change increases unemployment in the economy.
Some governments use industrial policy in an effort to nurture the industries and technologies of the
future, giving domestic industries an advantage over foreign competitors. But critics are wary of the
government’s ability to pick the winning technologies.
Convergence is a theory predicting that the standard of living around the world will grow more alike,
as poorer countries catch up with richer ones. Some Asian countries that had been poor are catching
up with the leaders, but many poor countries around the world have failed to close the gap.
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
classroom use.
TEACHING POINTS
1. This chapter shifts from short-run stabilization concerns to the long-run goals and
performance of the economy. Central to the notion of successful growth is the idea of
investment in capital, education, and research and development. The chapter considers at
length the determinants of labor productivity as well as overall economic growth. Each of
these is tied to thrift and investment of some sort.
2. Some students may be puzzled by the idea that technology and other capital can make labor
more productive. They may be accustomed to thinking that technology replaces labor in the
production process. You should emphasize two important considerations. First, not all
technology acts as a substitute for labor; some requires additional labor for operation and
maintenance but still produces more output per worker. Second, if some technology does
replace labor, this labor will find an outlet producing other products, thus increasing the
national output. In the long run, technological change makes labor more productive and
consequently increases living standards.
3. It is probably important to mention that a better-educated (more highly skilled) labor force
also requires thrift on the part of society. Society must divert current resources to build
educational facilities and research centers. On the individual level, each person must sacrifice
leisure to obtain the desired skills or education.
4. Students should be led through the discussion of the per-worker production function. The
effects on output per capita of both changes in the size of the labor force and the growth rate
of productivity should be discussed. If employment grows faster than the population as a
whole, output per capita can increase faster than productivity per worker. With a higher
percentage of the population working, output per capita can grow faster than output per
worker.
5. In discussing the theory of convergence, it is important to emphasize the factors that may
keep an economy from converging with an industrial economy. Those factors are (1) an
increase in birth rates, (2) differences in quality of human capital, and (3) lack of a stable
macroeconomic environment.
ANSWERS TO END-OF-CHAPTER QUESTIONS AND EXERCISES

Answers to Questions for Review
1. (Productivity) As discussed in the text, per capita GDP in many developing countries depends
on the fertility of land there. However, many richer economies have little land or land of poor
quality. How can a country with little land or unproductive land become rich?
The ability to produce food is important in certain countries with very large populations and
relatively small manufacturing sectors. Recalling that “land” includes all natural resources,
nations (such as Saudi Arabia and Kuwait) that rely on oil exports for revenue also depend on
the productivity of land.
Some small countries have eliminated their reliance on land productivity by developing
manufacturing sectors while importing the necessary raw materials or creating service sectors.
Switzerland is a small country with one of the highest per-capita income levels in the world. To
some extent, Sweden also relies on large exports of services, such as banking.
The United States is blessed with both high land productivity and a large manufacturing sector.
It exports large amounts of both agricultural products (such as wheat, soybeans, and corn) as
well as large amounts of manufactured goods (automobiles, computers, aircraft) and services
(banking, insurance).
2. (Labor Productivity) What two kinds of changes in the capital stock can improve labor
productivity? How can each type be illustrated with a per-worker production function? What
determines the slope of the per-worker production function?
The two kinds of changes are an increase in the quantity of capital and improvement in the
quality of capital. Quantity increases are represented by a movement along a given per-worker
production function’s curve. Quality improvements are illustrated by an upward rotation in the
curve. The per-worker production function slopes upward because more capital per worker
increases output per worker. However, the curve becomes less steep as more and more capital
is added due to the law of diminishing marginal returns.
3. (Slowdown in Labor Productivity Growth) What slowed the rate of growth in labor
productivity during the 1973-1982 period?
First, an increase in oil boosted inflation and contributed to three recessions. Second,
legislation to protect the environment and improve workplace safety caused production costs to
increase.
4. (Output per Capita) Explain how output per capita can grow faster than labor productivity. Is
it possible for labor productivity to grow faster than output per capita?
If employment grows faster than the population as a whole, output per capita can increase
faster than productivity per worker. With a higher percentage of the population working,
output per capita can grow faster than output per worker.
If population grows at a faster rate than employment, it is possible for labor productivity to
grow faster than output per capita.
5. (Technology and Productivity) What measures can government take to promote the
development of practical technologies?
The government can use taxes, subsidies, and regulations to promote particular technologies.
The government can provide tax credits or accelerate depreciation for selected areas. Subsidies
provide direct government underwriting of the costs of the necessary research and
development. Pollution regulations, for example, can encourage firms to develop new
technologies for controlling emissions, create more fuel-efficient automobiles, and so on.
6. (Basic and Applied Research) What is the difference between basic and applied research?
Relate this to the human genome project—research aimed at developing a complete map of
human chromosomes, showing the location of every gene.
Basic research is not designed for practical applications; it is the search for knowledge for the
sake of knowledge itself. Applied research uses basic research to answer specific questions (for
example, how to reduce wind resistance for an automobile) or develop specific products (for
example, the photocopying process). The human genome project is basic research, but it has
great potential for leading to applied research. Locating the genes for certain illnesses such as
classroom use.
breast cancer or cystic fibrosis can lead to the development of new therapies for treating these
illnesses.
7. (Rules of the Game) How do “rules of the game” affect productivity and growth? What types
of “rules” should a government establish to encourage growth?
Rules of the game are the formal and informal institutions that promote economic activity. A
stable political climate and well-established property rights are paramount to encouraging
investment. Improvements in political stability, the establishment and enforcement of property
rights, the creation of incentives for research and development, and improvements in
infrastructure would all encourage growth
8. (Research and Development) What’s the relevance of research and development to an

economy’s productivity? Among major economies, how does the United States rank in R&D
spending as a share of GDP?
Human capital has benefitted from better education, better health care, and more job training.
Better technology embodied in physical capital has also helped labor productivity. Because
technological change is the fruit of research and development (R&D), investment in R&D
improves productivity through technological discovery. Overall R&D spending in the United
States has remained constant, averaging 2.7% as a share of GDP, During the 1990s and in
2008, the United States ranked second among major economies behind Japan.
9. (International Productivity Comparisons) How does output per capita in the United States
compare with output per capita in other industrial economies? How does U.S. output per capita
compare with the world average?
Output per capita is total output divided by the population. The U.S. produces more output per
capita than any other major economy. Among the seven major industrialized market
economies, the U.S. growth in output per capita has also been high. Depending on political
and technological changes, the ranking of the U.S. has varied.
Per capita output in the United States, a world leader among major economies, is at least 150 times
that of the poorest economies. With nominal GDP per capita of $48,100 in 2011, the United
States stood alone at the top, with a per capita GDP 19 percent above second-ranked Canada
and at least 27 percent above the rest. Thus, the United States produced more per capita than
any other major economy. GDP per capita for the world was about $11,800 in 2011, up 2.6
percent from the year before. Hence, U.S. per capita income in 2011 was about four times the
world average.
10. (Industrial Policy) Define industrial policy. What are some arguments in favor and against
industrial policy?
Industrial policy is the use by the government of taxes, subsidies, and regulations, specifically
with the purpose of nurturing certain industries and technologies that the government considers
important for the country’s future health. Policies are designed to provide domestic producers
with an advantage over foreign producers.
One argument for industrial policy is that the necessary research and development to expand
the target industries is often very expensive—so much that an individual firm cannot raise the
needed funds. Another argument is that one firm’s research may provide spillover effects for
other industries—benefits that do not accrue to the developer. Because developers do not
realize all of the gains from their research and base their decisions only on the gains that they
do realize, there is a tendency to underinvest in research.
Critics of industrial policy believe the markets allocate scarce resources better than
governments do. There is also concern that industrial policy will evolve into a give away
program. And finally some believe that the focus should be on happiness and well-being, not
production.
11. (Technological Change and Unemployment) Explain how technological change can lead to
unemployment in certain industries. How can it increase employment?
Technological change can lead to unemployment if it reduces the number of workers needed to
produce a given amount of output. In addition, it can make certain skills obsolete so that
workers with those skills are no longer employed. However, technological change increases
labor productivity and can make output more affordable, leading to an increased quantity
demanded, increased production, and increased employment. Also, technological change can
lead to the development of new industries, which would result in the creation of new jobs.
12. (Productivity) What factors might contribute to a low level of productivity in an economy?
Regardless of the level of labor productivity, what impact does growth in labor productivity
have on the economy’s standard of living?
The productivity of an economy may be due to a variety of factors, such as (a) a low quality of
its workforce, (b) a low quantity of physical capital, (c) deficient quality of physical capital, (d)
a low level of technology, (e) poor methods for organizing production, and (f) institutional and
social factors that adversely affect incentives of the resource suppliers. As the growth rate of
productivity decreases, fewer goods and services are produced from a given amount of
resources, thus lowering the standard of living.
13. (CaseStudy: The Pursuit of Happiness) How would you explain the finding that people in high-
income economies seem happier than people in low-income economies, but, over generations,
Americans do not seem to become happier even though the nation grew richer?
There are two possible explanations. First, the luxuries of one generation become the
necessities of the next generation. People begin taking for granted products they once desired.
Second, if relative income is important, as it seems to be, then a general rise in average
incomes over time does not translate into a general rise in happiness because the average
relative position does not necessarily improve.
Answers to Problems and Exercises

14. (Growth and the PPF) Use the production possibilities frontier (PPF) to demonstrate
economic growth.
a. With consumption goods on one axis and capital goods on the other, show how the
combination of goods selected this period affects the PPF in the next period.
b. Extend this comparison by choosing a different point on this period’s PPF and
determining whether that combination leads to more or less growth in the next period.
classroom use.
a. An economy that produces more capital goods than consumer goods (point A on Graph
A below) will grow more in the future as reflected by the shifting out of the production
possibilities frontier from CI to CI.
b. If a point (B in Graph B) had been chosen that produced more consumption goods and
thus less capital goods than point A in Graph A, this country would not have
experienced as much future growth. The production possibilities curve would only have
shifted out a little, to I"C".
16. (Long-Term Productivity Growth) Suppose that two nations start out in 2013 with identical
levels of output per work hour—say, $100 per hour. In the first nation, labor productivity
grows by one percent per year in real terms. In the second, it grows by two percent per year
in real terms. Use a calculator or a spreadsheet to determine how much output per hour each
nation will be producing 20 years later. Then determine how much each will be producing
per hour 100 years later. What do your results tell you about the effects of small differences
in productivity growth rates?
Over long periods, small differences in productivity growth rates have significant impacts on
the economy’s ability to produce and, therefore, on the standard of living. The following
table shows that a one percent growth rate in the productivity of labor causes the value of the
output per worker to rise from $100 to $122 in 20 years. However, if the growth rate of
output is two percent, the increase in the value of the productivity of the worker is much
larger, rising from $100 to $149 in 20 years. After 100 years, the change in the value of
labor’s productivity is even more pronounced for the higher growth rate. At one percent, the
value has risen to $270, whereas at a growth rate of two percent, the value has risen to $724.
Just a one percentage point difference in growth rate creates a $454 dollar difference in
value over 100 years. At a one percent growth rate over 100 years, the value increases by
less than three times its original value. At a two percent growth rate, the value increases by
over seven times its original value.
1% Rate of Growth 2% Rate of Growth

Year in Output per Worker in Output per Worker
2013 $100 $100
2014 $101 $102
2015 $102 $104
2016 $103 $106
2017 $104 $108
2018 $105 $110
2019 $106 $113
2020 $107 $115
2021 $108 $117
2022 $109 $120
2023 $110 $122
2024 $112 $124
2025 $113 $127
2026 $114 $129
2027 $115 $132
2028 $116 $135
2029 $117 $137
2030 $118 $140
2031 $120 $143
2032 $121 $146
2033 $122 $149 20 years
--- --- --- ---
2113 $270 $724 100 Years
17. (Technological Change and Unemployment) What are some examples of technological
change that has caused unemployment? And what are some examples of new technologies
that have created jobs? How do you think you might measure the net impact of technological
change on overall employment and GDP in the United States?
Technological change in the banking industry has reduced the need for bank tellers. ATMs,
debit cards, and electronic banking perform most of the tasks a bank teller once performed.
At the same time, the new technology of the banking industry has created a need for
management information systems experts and technicians and for calm, verbal people to
explain the system to a worried, frustrated, confused customer trying to bank in this new
virtual banking system. Often the technological change decreases the need for certain
positions but creates new positions to facilitate and carry out the new technology.
classroom use.
Both the growth rate of GDP and the direction of change and the level of the unemployment
rate can give some measure of the net impact of technological change on overall employment
and GDP in the United States. If unemployment rates have fallen in the last year, there is no
evidence that technological change has caused a loss of jobs. In fact, a lower unemployment
rate usually means that there are more jobs in the economy. If the rate of growth of real
GDP was positive and strong during the last year, there is evidence of growth in income and
the standard of living.
18. (Shifts in the PPF) Terrorist attacks foster instability and may affect productivity over the
short and long term. Do you think the September 11, 2001, terrorist attacks on the World
Trade Center and the Pentagon affected short- or long-term productivity in the United States?
Explain your response and show any movements in the PPF.
The attacks affected short-term productivity because production capabilities for some
sectors, especially financial services in the New York area, were negatively impacted by
personnel killed and injured, resources destroyed, and the time spent repairing facilities and
relocating. Long-term productivity may have been affected if businesses chose to set up
elsewhere or found that production requires more resources than in the past. Reactions to
the disaster have led to technological and other changes which ultimately enhance
production capabilities.
Any loss of productivity shifts the curve inward (or leftward) while improvements lead to an
outward (or rightward) shift.

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Macroeconomics A Contemporary

Approach 10th Edition McEachern

II. Productivity and Growth in Practice (Slides 18-20)

A. Education and Economic Development (Slides 21-22)

III. Other Issues of Technology and Growth

A. Does Technological Change Lead to Unemployment?(Slide 33)

CaseStudy: Income and Happiness (Slides 41-43)

ANSWERS TO END-OF-CHAPTER QUESTIONS AND EXERCISES

8. (Research and Development) What’s the relevance of research and development to an

Answers to Problems and Exercises

1% Rate of Growth 2% Rate of Growth

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