Chapter 21
Productivity and Growth
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© 2006 Thomson/South-Western
Standard of Living
Standard of living: measured by the amount of
goods and services available on average per
person

Grows over the long run because of:
increases in the amount and quality of resources, especially
labor and capital
better technology
improvements in the rules of the game that facilitate
production and exchange
tax laws
property rights
patent laws
legal system
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Economic Growth
Growth in the labor supply
Growth in the capital stock
Improvements in technology
Expand the frontier by making more efficient
use of existing resources
Improvements in the rules of the game
Improvements that nurture production and
exchange will promote growth
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Exhibit 1: Capital Produced and Growth
In the left panel, the economy has chosen point A, which shifts the PPF from CI this year to
C'I' next year
If more capital goods are produced this year, (point B), the PPF will shift outward farther
next year to C"I"
An economy that invests more in capital – gives up more consumer goods – will experience
larger economic growth
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What is Productivity?
Production is a process that transforms resources
into products
Productivity: the ratio of a specific measure of
output, such as real GDP, to a specific measure of
input
measures how efficiently resources are employed
the higher the productivity, the more goods and services
that can be produced from a given amount of resources
and the farther out will be the PPF
total output divided by the amount of a particular kind of
resource employed

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Labor Productivity
Output per unit of labor and measures total
output divided by the hours of labor employed
to produce that output
Most commonly used resource to measure
productivity
Accounts for a relatively large share of the cost of
production
More easily measured than other inputs
Statistics more readily available
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Labor Productivity
 Resource most responsible for increasing labor
productivity is capital
 As economy accumulates more capital per worker, labor
productivity increases
 Two broad categories of capital
 Human Capital
Accumulated knowledge, skill, and experience of the labor
force
More human capital the higher the productivity
Physical Capital
Includes the machines, buildings, roads, airports,
communication networks and other manufactured
creations used to produce goods and services
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Per-Worker Production Function
The relationship between the amount of
capital per worker in the economy and
average output per worker
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Exhibit 2: Per-Worker Production Function
Any point on the
production function, PF,
shows how much output
per worker can be
produced for a given
amount of capital per
worker
When there are k units
of capital per worker,
average output per
worker in the economy is
y
Upward slope of the
curve occurs because an
increase in capital per
worker helps each
worker produce more
output
Shape reflects the law
of diminishing returns
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Exhibit 3: Impact of a Technological
Breakthrough
More output is
produced at each level
of capital per worker
Technological
change usually
improves the quality
of capital and
increases
productivity, shown
by the upward
rotation from PF to
PF'
k
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Economic Growth
Two kinds of changes in capital improve
worker productivity:
Increase in the quantity of capital per
worker
Reflected by a movement along the per-worker
production function
An improvement in the quality of capital per
worker
Reflected by technological change that rotates
the curve upward
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Rules of the Game
Refers to the formal and informal institutions
that promote economic activity
Laws, customs, conventions, and other institutional
elements that encourage people to undertake
productive activity
Stable political environment and system of welldefined property rights
Improvements in the rules of the game could
result in more output for each level of capital
 upward rotation in the per-worker
production function
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Productivity / Growth in Practice
World economies sorted into two broad
groups:
Industrial market countries or developed
countries
20% of world’s population
first to experience long-term economic growth
Developing countries
80% of worlds population
Majority of workers employed in agriculture
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Education and Economic Development
Important source of productivity is the quality
of labor
Contribution of education to the process of
economic development:
Makes workers aware of the latest production
techniques
Makes workers more receptive to new ideas and
methods
Countries with the most advanced educational
systems were first to develop, while developing
economies have far lower levels of education
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Exhibit 4: Average Years of Education of
Working Age Population
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Exhibit 5: Long-Term Trend in U.S. Labor
Productivity Growth: Annual Average by Decade
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U.S. Labor Productivity
Over long periods, small differences in
productivity can make huge differences on
the economy’s ability to produce and
therefore on the standard of living.
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Exhibit 6: U.S. Productivity Growth Slowed
From 1974 to 1982, and Then Rebounded
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Output Per Capita
If labor productivity did not increase,
total output would still grow if the
quantity of labor increased
Labor productivity equals real GDP divided
by the quantity of labor
Real GDP equals labor productivity times
the quantity of labor
Therefore total output can grow as a result
of greater labor productivity, more labor, or
both
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Output Per Capita
Output per capita
Real GDP divided by the population
Best measure of economy’s standard of
living
Indicates how much an economy produces
on average per person
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Output Per Capita
Output will increase if
labor productivity increases for a given workerpopulation ratio
the worker-population ratio increases for given
labor productivity
labor productivity and the worker-population both
increase
Output per capita would increase as long as an
increase in one of these three factors more than
offsets any decrease in the other two
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Exhibit 7: Real GDP Per Capita Has
Nearly Tripled Since 1959
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Exhibit 8: U.S. GDP Per Capita is Highest
of Major Economies
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Exhibit 9: U.S. Real GDP Per Capita Outgrew
Most Other Major Economies Since 1982
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Technological Change and Unemployment
Technological change usually reduces the
number of workers needed to produce a
given amount of output
Technological change also can increase
production and employment by making
products more affordable
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Research and Development
Basic research
Search for knowledge without regard to how that
knowledge will be used
First step toward technological advancement
Less immediate payoff yet yields a higher rate of
return to society as a whole
Applied research
Seeks to answer particular questions or
applies scientific knowledge to development
of specific products
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Exhibit 10: R&D Spending as a Percentage of GDP for
Major Economies During the 1980s and 1990s
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Convergence Theory
Convergence theory: predicts that the standard
of living in economies around the world will grow
more similar over time, with poorer countries
eventually catching up with richer ones
What’s the evidence on convergence?
Some poor countries have begun to catch up with the
richer ones
Among the nations that comprise the poorest third of
the world’s population, the standard of living in these
countries has grown somewhat in absolute terms, but
fallen farther behind in relative terms
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Convergence Theory
Reasons why the poorest countries have not
gained:
Birth rates are nearly double those in richer ones
Vast differences in the quality of human capital
across countries
While technology may be portable, knowledge, skill, and
training required to take advantage of it may not be
Some countries lack the stable macroeconomic
environment, established institutions, and
infrastructures needed to nurture economic growth
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Industrial Policy
Industrial policy: the view that government—using
taxes, subsidies, and regulations—should nurture
industries and technologies of the future, giving
them an advantage over foreign competition
Two concerns about technologies of the future:
They will require huge sums to develop and implement
and firms may not easily raise or put at risk these large
sums
Some technological breakthroughs spill over to other
firms and other industries
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