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Reading materials
UNIT 4 N. Gregory Mankiw (2021), Principles of Economics 9th edition,
Production and Growth Cengage Learning, ISBN 978-0-357-03831-4

CHAPTER 25: Production and Growth

LECTURER: Assoc.Prof. HA QUYNH HOA, PhD

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Incomes and Growth Around the World

Look for the answers to these questions:

u What are the facts about living standards and growth rates
around the world?
u Why does productivity matter for living standards?
u What determines productivity and its growth rate?
u How can public policy affect growth and living standards?

3 FACT 1: Vast differences in living standards around the world.

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FACT 2: Great variation in growth rates across countries.

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The Magic of Compounding and the Rule of 70 Economic Growth around the World
Rule of 70
If a variable grows at the rate of x percent per year, then that variable u Because of differences in growth rates
doubles in approximately (70/x) years. Ranking of countries by income changes substantially over time
Example: o Poor countries are not necessarily doomed to poverty forever,
e.g. Singapore incomes were low in 1960 and are quite high now
- If the growth rate of GDP per capita is 1%/year, it takes 70/1= 70
years for GDP per capita to double. o Rich countries can’t take their status for granted:
They may be overtaken by poorer but faster-growing countries
- If the growth rate of GDP per capital is 2%/year, it takes 70/2= 35
years for GDP per capita to double.
- ….

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Economic Growth around the World Productivity

A country’s standard of living Văn bản
Questions:
depends on its ability to produce goods and services
Ø Why are some countries richer than others?
Productivity
Ø Why do some countries grow quickly while others seem stuck in a
poverty trap? u Quantity of goods and services Produced from each unit of labor input
Ø What policies may help raise growth rates and long-run living u Productivity = Y/L (output per worker), where
standards? • Y = real GDP = quantity of output produced
• L = quantity of labor

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The Production Function Properties of Production Function Y = A F(L, K, H, N)

u constant returns to scale:

The production function Y = A F(L, K, H, N)
Changing all inputs by the same percentage causes output to change by that
o F( ) is a function that shows how inputs are combined to produce output
percentage.
o “A” = the level of technology
u increasing returns to scale
o L= quantity of labor
Changing all inputs by the same percentage causes output to change higher than that
o K= quantity of physical capital percentage
o H= quantity of human capital u diminishing returns to scale
o N= quantity of natural resources Changing all inputs by the same percentage causes output to change lower than that
percentage

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The Production Function Y = A F(L, K, H, N)

Determinants of Productivity: “K”
u If we multiply each input by 1/L, then output is multiplied by 1/L:
Y/L = A F(L/L, K/L, H/L, N/L)
u Physical capital, K
Or: Y/L = A F(1, K/L, H/L, N/L)
Stock of equipment and structures used to produce goods and services
In short: Y/L = A F(K/L, H/L, N/L)
u Physical capital per worker, K/L
u This equation shows that productivity (Y/L, output per worker) depends on:
Productivity is higher when the average worker has more capital
• The level of technology, A
(machines, equipment, etc.).
• Physical capital per worker, K/L
• An increase in K/L causes an increase in Y/L
• Human capital per worker, H/L
• Natural resources per worker, N/L

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Determinants of Productivity: “H” Determinants of Productivity: “N”

u Natural resources, N
u Human capital, H
Inputs into production that nature provides (land, rivers, and mineral deposits)
Knowledge and skills that workers acquire through education, training, and
experience u Two forms of N:
• Renewable Natural resources: solar energy, wind, falling water, the heat of the earth
u Human capital per worker, H/L
(geothermal), plant materials (biomass), waves…
Productivity is higher when the average worker has more human capital • Nonrenewable Natural resources: oil, natural gas, and coal.
(education, skills, etc.).
u Natural resources per worker, N/L
• An increase in H/L causes an increase in Y/L.
Other things equal, more N allows a country to produce more Y
• An increase in N/L causes an increase in Y/L
Natural resources can be important BUT NOT necessary for an economy to be
13 highly productive in producing goods and14services.

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Determinants of Productivity: “A” Determinants of Productivity: “A” vs. “H”

u Technological knowledge Technological knowledge vs. Human capital
Society’s understanding of the best ways to produce goods and services u Technological knowledge
Technological progress means: Refers to society’s understanding of how to produce goods and services
• A faster computer, a higher-definition TV, microchip technology... u Human capital
• Also, any advance in knowledge that boosts productivity: Results from the effort people expend to acquire this knowledge
allows society to get more output from its resources
u Both are important for productivity
e.g., Henry Ford and the assembly line (1913).
u Some technology is common knowledge: after one person uses it, everyone
becomes aware of it. The discovers have a temporary right to be its exclusive
producer. When the time expires, others producers can use this technology.

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Public policies push up productivity and

Productivity is so important standard of living

u Productivity is the key determinant of living standards 1. Saving and investment

When a nation’s workers are very productive, real GDP is large and 2. Education
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incomes are high 3. Health and nutrition
u Productivity growth is the key determinant of growth in living standards
4. Property rights and political stability
When productivity grows rapidly, so do living standards 5. Free trade
6. Research and development
7. Population growth

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#1. Saving and Investment Diminishing Returns

u Raise future productivity u Policies that raise saving and investment

o Invest more current resources in the production of capital, K
o Trade-off: since resources scarce, producing more capital requires
producing fewer consumption goods
u Reducing consumption = increasing saving (today)
à More investment (future)
o Fewer resources are used to make consumption goods
o More resources: to make capital goods
o K increases, rising productivity and living standards
o This faster growth is temporary, due to diminishing returns to capital:
As K rises, the extra output from an additional unit of K falls….

à Higher productivity (future)

à Higher quantity of goods and servises (future)

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Diminishing Returns The catch-up effect: the property whereby poor countries
tend to grow more rapidly than rich ones
Output per worker
(productivity) Y/L
Y/L
If workers
Rich country’s
have little K,
growth
giving them more
increases their
productivity a lot.

Poor country’s
growth
If workers already have a
lot of K,
giving them more
increases productivity
fairly little. K/L
K/L Poor country
starts here Rich country starts here
Capital per worker 22
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Investment from Abroad Investment from Abroad

u Another way for a country to invest in new capital
u Foreign direct investment
Capital investment that is owned and operated by a foreign entity
u Foreign portfolio investment
Investment financed with foreign money but operated by domestic
residents
Benefits from investment from abroad
o Some benefits flow back to the foreign capital owners
o Increase the economy’s stock of capital
o Higher productivity and higher wages
o State-of-the-art technologies developed in other countries
o Especially good for poor countries that cannot generate enough saving to
fund investment projects themselves

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#2. Education #3. Health and Nutrition

u Health care expenditure
u Education, investment in human capital
Is a type of investment in human capital: healthier workers are more
• Gap between wages of educated and uneducated workers productive
In the U.S., each year of schooling raises a worker’s wage by 10% u In countries with significant malnourishment, raising workers’ caloric
• Opportunity cost: wages forgone intake raises productivity:
Spending a year in school requires sacrificing a year’s wages now • 1962–1995, caloric consumption rose 44% in S. Korea, and
to have higher wages later economic growth was spectacular.
u Problem for poor countries: Brain drain • Nobel winner Robert Fogel: 30% of Great Britain’s growth in 1790–
1980 was due to improved nutrition

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#3. Health and Nutrition #4. Property Rights and Political Stability
u Vicious circle in poor countries Markets are usually a good way to organize economic activity
o Poor countries are poor because their populations are not healthy u To foster economic growth
o Populations are not healthy because they are poor and cannot afford o Protect property rights (the ability of people to exercise authority over
better healthcare and nutrition the resources they own)
u Virtuous circle Courts – enforce property rights
o Policies that lead to more rapid economic growth would naturally o Promote political stability
improve health outcomes, which in turn would further promote u Property rights:
economic growth
Prerequisite for the price system to work

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#4. Property Rights and Political Stability #4. Property Rights and Political Stability
u Lack of property rights, a major problem u When people fear their capital may be stolen by criminals/confiscated by a
• Contracts are hard to enforce corrupt government
• Fraud, corruption often goes unpunished • Less investment, including from abroad, and the economy functions less
efficiently
Firms must bribe government officials for permits
• Result: lower living standards
u Political instability (e.g., frequent coups)
u Economic stability, efficiency, and healthy growth
Creates uncertainty over whether property rights will be protected in the future
• Require law enforcement, effective courts, a stable constitution, honest
government officials

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#5. Free Trade #5. Free Trade

Trade can make everyone better off
u Inward-oriented policies u Trade has similar effects as discovering new technologies
i.e. tariffs, limits on investment from abroad Improves productivity and living standards
Aim to raise living standards by avoiding interaction with other countries u Countries with inward-oriented policies have generally failed to create growth.
u Outward-oriented policies e.g., Argentina during the 20th century.
i.e. elimination of restrictions on trade or foreign investment u Countries with outward-oriented policies have often succeeded
Promote integration with the world economy e.g., South Korea, Singapore, Taiwan after 1960

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#6. Research and Development #7. Population Growth

u Large population
u Technological progress o More workers to produce goods and services: larger total output of
Main reason why living standards rise over the long run goods and services
u Knowledge is a public good o More consumers
Ideas can be shared freely, increasing the productivity of many u Population growth may affect living standards in 3 different ways:
u Policies to promote technological progress: 1. Stretching natural resources
Patent laws; Tax incentives or direct support for private sector R&D 2. Diluting the capital stock
Grants for basic research at universities 3. Promoting technological progress

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#7. Population Growth #7. Population Growth

2. Diluting the capital stock
1. Stretching natural resources
o High population growth (higher L)
u 200 years ago, Malthus argued that population growth will:
o Spread the capital stock more thinly (lower K/L)
o Strain society’s ability to provide for itself
o Lower productivity and living standards
o Mankind - doomed to forever live in poverty
To combat this, many developing countries use policy to control population growth
u Since then, the world population has increased sixfold and living standards
increased § Government regulation (China’s one child law)
o Malthus failed to account for technological progress and productivity growth § Increased awareness of birth control
§ Equal opportunities for women (Promote female literacy to raise opportunity
cost of having babies)

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#7. Population Growth Conclusion

3. Promoting technological progress
World population growth
§ Engine for technological progress and economic prosperity
§ More people = More scientists, more inventors,
more engineers = More frequent discoveries
Michael Kremer, human history:
o Growth rates increased as the world’s population increased
o More populated regions grew faster than less populated ones
u In the long run
Living standards are determined by productivity
u Policies that affect the determinants of productivity
Will therefore affect the next generation’s living standards
u One of these determinants: saving & investment
Next chapter: how saving and investment are determined, and how
policies can affect them

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Summary Summary
• Policies can affect the following, each of which has important effects on
• There are great differences across countries in living standards and growth
growth:
rates.
üSaving and investment; International trade
• Productivity (output per unit of labor) is the main determinant of living
standards in the long run. üEducation, health & nutrition
• Productivity depends on physical and human capital per worker, natural üProperty rights and political stability
resources per worker, and technological knowledge. üResearch and development
• Growth in these factors—especially technological progress—causes growth üPopulation growth
in living standards over the long run.
• Because of diminishing returns to capital, growth from investment eventually
slows down, and poor countries may “catch up” to rich ones.

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