In the last two chapters we saw two major issues that

haunts the policy makers the most,

I.E GDP and CPI, income of a nation and price level in
a nation.

We have seen in the previous chapter how to measure a

nation’s income and how some countries have a higher
GDP than others.
Now let me ask you one question, Why do some countries
around the world have a higher income than others?
In this chapter we will look at those factors
which can increase the Real GDP of a
nation.

What do you reckon are those factors?

Economic Growth around the World

• The poorest countries have average levels of income not seen in the
developed world for many decades. The typical resident of Pakistan in
2017 had about the same real income as the typical resident of the
United Kingdom in 1870. The typical Bangladeshi in 2017 had less real
income than the typical American in 1870.
• Explaining why living standards vary so much around the world is, in
one sense, very easy. The answer can be summarized in a single word
—productivity.
Why is Productivity so important?
The Robinson Crusoe Story
Daniel Defoe’s famous novel Robinson Crusoe about a sailor stranded on a
desert island. Because Crusoe lives alone, he catches his own fish, grows his
own vegetables, and makes his own clothes.
We can think of Crusoe’s activities—his production and consumption of fish,
vegetables, and clothing—as a simple economy. By examining Crusoe’s
economy, we can learn some lessons that also apply to more complex and
realistic economies.
What determines Crusoe’s standard
of living?
In a word, productivity, the quantity of goods and services
produced from each unit of labor input.
If Crusoe is good at catching fish, growing vegetables, and
making clothes, he lives well. If he is bad at doing these
things, he lives poorly.
Because Crusoe gets to consume only what he produces, his
living standard is tied to his productivity.
How Productivity is Determined? What are
the determinants of Productivity?
• How can Robinson Crusoe be more Productive?
1. If he has better tools to catch fish like better fishing poles.
2. If he finds a place on the island which is fertile for growing vegetables
and finds a place where he can find plenty of fish.
3. If he has been trained on the advanced methods of fishing and farming.
4. If he invents a better fishing technique

What are we talking about? Physical Capital, Natural Resources, Human

Capital and Technological know how.
Determinants of Productivity:
• Physical Capital Per Worker:
Workers will be able to produce more if they have tools to work with.
Physical capital includes the stock of equipments and structures to
work. Just image the Tesla or Merc factory.
• Human Capital Per Worker
Human capital is the economist’s term for the knowledge and skills
that workers acquire through education, training, and experience.
Human capital includes the skills accumulated in early childhood
programs, grade school, high school, college, and on-the-job training
for adults in the labor force.
Determinants of Productivity:
• Natural Resources per Worker
Natural resources are inputs into production that are provided by
nature, such as land, rivers, and mineral deposits. Natural resources
take two forms: renewable and nonrenewable.
Differences in natural resources are responsible for some of the
differences in standards of living around the world.
Today, some countries in the Middle East, such as Kuwait and Saudi
Arabia, are rich simply because they happen to be on top of some of
the largest pools of oil in the world.
Determinants of Productivity:
• A fourth determinant of productivity is technological knowledge—the
understanding of the best ways to produce goods and services.
• Henry Ford successfully introduced assembly-line production.
• When a pharmaceutical company discovers a new drug.
• All these forms of technological knowledge are important for the
economy’s production of goods and services.
Economic Growth and Public Policy
• Saving and Investment
Saving is the amount that individuals save in the financial system of a country.
More the savings, less will be available for current consumption.
More the savings, more capital creation happens.
A country which has high savings and investment grows substantially.
Economic Growth and Public Policy
• Saving and Investment
Diminishing returns of Capital and Catch Up Effect
With the nation saving more, fewer resources are needed to make
consumption goods and more resources are available to make capital
goods. As a result, the capital stock increases, leading to rising
productivity and more rapid growth in GDP. But how long does this
higher rate of growth last?

The traditional view of the production process is that capital is subject

to diminishing returns: As the stock of capital rises, the extra output
produced from an additional unit of capital falls.
Economic Growth and Public Policy
Economic Growth and Public Policy
• Investment from Abroad
• FDI and FPI
• Education

• Health and Nutrition

• Property Rights and Political Stability

• Free Trade

• Research and Development

• Population Growth- Stretch of Natural Resources, Diluting Capital Stock,

Promoting Technological Progress