Chap 12 Determinants of GDP and growth in GDP

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Chap 12 - Determinants of GDP and growth in GDP

• Measuring growth in GDP
• The production function, its properties and the
  measure of productivity
• Determinants of productivity
• Economic growth, its determinants and public
  policy

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I. Measuring growth in GDP

• Compounding refers to the accumulation of a
  growth rate over a period of time.
• growth rate from the year (t 1) to the year t
  is measured as,
• g (Yt Yt-1 ) / Yt-1 , where Yt represents
  output at time t
• hence, Yt Yt-1(1 g).
• Assuming g to be constant over all years,
  starting from an initial year 0, after T years,
  output becomes
• YT Y0 (1 g)T.
• Even if g and Y0 are small, YT can become very
  large if T is sufficiently long.

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The Variety of Growth Experiences
.
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• How the figures in column 5 are calculated
• for Japan, 23,400 1,196 (1 g)107. The
  solution of g for this equation is 2.82.
• Doubling time of the level of output
• According to the rule of 70, if some variable
  grows at a rate of x percent per year, then that
  variable doubles in approximately 70/x years.
• 5,000 invested at 7 percent interest per year,
  will double in size in 10 years, because 70/7
  10

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II. The Production Function, its properties and
the measure of productivity

• Y A F(L, K, H, N)
• 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
• F( ) is a function that shows how the inputs
  are combined.

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The Production Function

• A production function has constant returns to
  scale if, for any positive number x,
• xY A F(xL, xK, xH, xN)
• That is, a doubling of all inputs causes the
  amount of output to double as well.

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The Production Function

• Production functions with constant returns to
  scale have an interesting implication.
• Setting x 1/L,
• Y/ L A F(1, K/ L, H/ L, N/ L)
• Where
• Y/L output per worker
• K/L physical capital per worker
• H/L human capital per worker
• N/L natural resources per worker

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III. Determinants of productivity

• The preceding equation says that productivity
  (Y/L) depends on physical capital per worker
  (K/L), human capital per worker (H/L), and
  natural resources per worker (N/L), as well as
  the state of technology (A).
• Physical capital K, labor H and natural resources
  N are called factors or production.
• Physical capital K is referred to as a produced
  factor of production. Labor or human capital like
  physical capital can be enhanced through
  training, education etc.

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• IV. Economic growth, its determinants and public
  policy
• Determinants of economic growth
• domestic savings and investment
• To increase physical capital stock for the
  future, society must consume less and save more
  of its current income.
• role of financial markets financial markets
  bring together savers/lenders or suppliers of
  funds and borrowers or users (for investment
  purposes) of funds.
• 2. foreign investment
• can take the form of foreign direct investment or
  foreign portfolio investment

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Increase in domestic investment and increase in
foreign investment do not have the same effect on
GDP and economic growth. 3. education or
investment on human capital Human capital
generates positive externality. Hence brain drain
creates a negative externality. Public policies
subsidizing education has a favorable impact on
growth. 4. diminishing returns (catch-up effect)
or limits on growth all factors of production, in
particular capital is subject to diminishing
returns this imposes a limit on growth
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public policy conducive to growth well defined
property rights political stability free
trade control of population growth fostering R D
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Growth and Investment
(a) Growth Rate 1960-1991
(b) Investment 1960-1991
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The Growth in Real GDP Per Person
4.0
3.5
3.0
2.5
Growth Rate ( per year)
2.0
1.5
1.0
0
1870-
1890-
1910-
1930-
1950-
1970-
1890
1910
1930
1950
1970
1990