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MACROECONOMICS 1
TOPIC IV: Production and Growth

CORE CONCEPTS

Production Possibility Frontier (PPF)


Factors of production
Productivity and growth
Public policy and economic growth

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PRODUCTION POSSIBILITIES
FRONTIER
How to achieve the greatest possible satisfaction
of societys material wants given scare resources?
Full employment
Full production

Allocation efficiency

Productive efficiency

PRODUCTION POSSIBILITIES FRONTIER


Represents the maximum possible combinations of
goods and services that can be produced with a
given quantity of factors and production and given
technology.

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PRODUCTION AND GROWTH


A countrys standard of living depends on its
ability to produce goods and services.
Living standards, as measured by real
GDP/person, varied significantly among nations.
Annual growth rates that seem small, become
large when compounded for many years.

PRODUCTIVITY:
ITS ROLE AND DETERMINANTS
Productivity refers to
the amount of goods
and services produced
for each hour of a
workers time.
Key role in determining
living standards for all
nations in the world.

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PRODUCTIVITY

HOW PRODUCTIVITY IS
DETERMINED
To understand the large difference in living
standards across countries, we must focus on
the production of goods and services.
The inputs used to produce goods and services
are called the factors of productions.

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HOW PRODUCTIVITY IS
DETERMINED
The factors of
production include:
physical capital
human capital
natural resources
technological
knowledge

PHYSICAL CAPITAL
Physical capital is a produced factor of production:

It is an input into the production process that


in the past was an output from the
production process.

It is the stock of equipments and structures


that are used to produce goods and
services;

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HUMAN CAPITAL
The economists term for the knowledge and
skills that workers acquire through education,
training and experience.

NATURAL RESOURCES
Natural resources are inputs used in production
that are provided by nature:

Renewable resources include forests.

Natural resources can be important but are


not necessary for an economy to be highly
productive in producing goods and services.

Non-renewable resources include petroleum


and coal.

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TECHNOLOGICAL KNOWLEDGE
This is societys understanding of the best ways
to produce goods and services.

THE PRODUCTION FUNCTION


Production function describes the relationship between the
quantity of inputs used in production and the quantity of
output from production.
Y = A*F(L, K, H, N) where: F() shows how the inputs are
combined:
Y = quantity of output
A = available production technology
L = quantity of labor
K = quantity of physical capital
H = quantity of human capital
N = quantity of natural resources

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THE PRODUCTION FUNCTION


A production function has constant return to
scale if, for any positive number x:
xY = A*F(xL, xK, xH, xN)
It has an interesting implication, setting X = 1/L:
Y/L = A*F(1, K/L, H/L, N/L) Y/L = output per worker

K/L = physical capital per worker

What does the


equation mean?

H/L = human capital per worker


N/L = natural resources per worker

BRITAINS PRODUCTIVITY

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INGREDIENTS FOR
ECONOMIC GROWTH

ECONOMIC GROWTH AND


PUBLIC POLICY
Govt policies to raise productivity and living standards:
1. encourage saving and investment
2. encourage investment from abroad
3. encourage education, health and nutrition
4. establishing secure property rights and maintain
political stability
5. promoting free trade
6. promoting research and development

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1. SAVING AND INVESTMENT


One way to raise future productivity is to invest more current
resources in the production of capital.
As the stock of capital , the extra output produced from an
additional unit of capital ; this property is called diminishing
returns.
Because of diminishing returns, an increase in the saving rate
leads to higher growth only for a while.
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.

2. INVESTMENT FROM ABROAD


Foreign Direct Investment (FDI): capital
investment owned and operated by a foreign
entity.
Foreign Portfolio Investment (FPI): investment
financed with foreign money but operated by
domestic residents

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3. EDUCATION, HEALTH AND


NUTRITION
Educated people with new ideas would benefit
the society
Brain drain in poor countries
Health of population would affect productivity
and living standards

POPULATION GROWTH
Debate about how population growth affects a
society
Population growth interacts with other factors of
production:

stretching natural resources


diluting the capital stock
promoting technological progress

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DECLINING LETHALITY

INVESTING IN YOURSELF

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4. PROPERTY RIGHTS AND


POLITICAL STABILITY
Property rights refer to the ability of people to
exercise authority over the resources they own.

An economy-wide respect for property rights


is an important prerequisite for the price
system to work.

It is necessary for investors to feel that their


investments are secure.

5. FREE TRADE
Trade is, in some ways, a type of technology
Eliminating trade restrictions will be a technological
advance and affect economic growth.
Some countries engaged in:

inward-oriented trade policies, avoiding interaction


with other countries (eg, North Korea)

outward-oriented trade policies, encouraging


interaction with other countries. (eg, Singapore)

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6. RESEARCH AND DEVELOPMENT


The advance of technological knowledge has
led to higher standards of living:

Most technological advance comes from


private research by firms and individual
inventors

Govt can encourage the development of


new tech. through research grants, tax
breaks and the patent system

THE CATCH-UP EFFECT


1. Is Chinas potential GDP growing? If yes, what
is the cause of this growth?
2. Is China experiencing an increase of a
decrease in its real GDP per person? Explain.
3. How does Chinas economic growth compare to
Vietnams economic growth over the last 20
years?

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SUMMARY
Economic prosperity, as measured by real GDP
per capita, varies substantially around the world.
Living standards depends on the ability to
produce goods and services of an economy
Productivity depends on the amount of physical
capital, human capital, natural resources and
technological knowledge available to workers,
which is illustrated by the production function

SUMMARY
Govt policies can influence the economys
growth rate in many different ways.
The accumulation of capital is subject to
diminishing returns:

higher saving  higher growth for a period of


time, but growth will eventually slow down.

the return on capital is especially high in poor


countries

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