Management and

Business in Context 2
seminar 6.

Explaining Growth and

Inequality
Thinking Problem

 Why is the average American so much

richer than the average Indian?
 International comparison of living standards
 Explaining inequality

 Why are you so much more prosperous

than your great-great-grandparents
were?
 Intertemporal comparison of living standards
 Explaining economic growth
EXPLAINING ECONOMIC
GROWTH
 Economic Growth

 Measurement ?
 Real vs. nominal growth
 Economic output vs. living standard
 Economic growth:
 The increase in real GDP
 Living standard
 The increase in real GDP per capita
 In ch.21: PPP adjusted 2005 constant dollars
 Exponential growth
 (seminar 4.)
Real GDP Increases If

 More output is produced

 More resources used
 Better technology, higher productivity
 Aggregate Production Function
 GDP = Y = A x F(K, H)
 K is the physical capital stock
 H is the total efficiency units of labor
 F() is a mathematical function
 A is an index of technology
 Productivity

 The value of G&S that a worker

generates from an hour of work
 Productivity is the ultimate driver of
economic growth and inequality across
countries
 Determinants of productivity
 Human capital
 Physical capital
 Technology
Human Capital

 The stock of skills embodied in labor that

can be used to produce output
 The # of workers is poor indicator of
human capital
 Total efficiency units of labor: H = L × h
 L is total number of workers
 h is the average human capital
Physical Capital

 The stock of manmade structures and

equipment that can be used to produce
output
 It is the result of Investment
 Conscious decision of firms
 Financed by loans from the financial sector

 Natural resources
 Can’t be reproduced by humans
 Technology

 The ways and means to produce more

output with the same amount of
resources
 Is different from physical capital
 Can’t be bought, must be learned
 More advanced technology
 Higher productivity
 More output can be produced with the same amount
of K and H
Aggregate Production Function

 Similar to the production function of an

individual firm
1) “More is better”
 An increase in either K or H, holding the other factor
constant, leads to an increase in GDP
2) Law of Diminishing Marginal Product
 The marginal contribution of either K or H to GDP
diminishes when we increase the quantity used of that
factor (holding all other factors of production constant)
APF with constant H

Exhibit 20.7
© 2015 Pearson Education, Ltd.
APF Shifts with Better Technology

Exhibit 20.9
© 2015 Pearson Education, Ltd.
Dimensions of Technology

 Superior knowledge
 of how to produce new G&S
 of how to perform certain tasks more efficiently
 Knowledge is embodied either in H or K
 More efficient production processes
 The ability to prodice the maximal amount of output from a
given amount of factors and knowledge
 Efficiency of production depends on
entrepreneurship, leadership
 Management itself is a special skill
Research and Development (R&D)

 Activities directed at improving

tehcnology
 In the United States in 2007
 1.4 million people worked as researcher
 $430 billion (or 2.8% of GDP) spent on (R&D)
 $270 billion spent by businesses
Investment

 Is necessary but not sufficient

 Necessary: because of depreciation and
population growth
 The capital/labour ratio will decline
 Not sufficient because of …
 Diminsihing marginal product of capital
 Countries that invest more tend to have
high growth rates
 Cause or consequence?
 Growth and Investment
China

Australia

India

Germany

Egypt, Arab Rep.

Sweden

Brazil

United Kingdom GDP Growth Rate 1961 - 2011 average

Bangladesh

Central African Republic

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0

China
Japan
Australia
Norway
India
Mexico
Germany
South Africa
Egypt, Arab Rep.
Argentina
Sweden
Afghanistan
Brazil Gross Capital Formation
United States
United Kingdom
(Investment)
Pakistan
Bangladesh
1961 - 2011 average
Zimbabwe
Central African Republic
0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 40.0
 Catch-up Growth

 Poor countries tend to grow faster

 They adopt the technologies of the richest countries
 Mistakes can be avoided

 Examples
 Chile, Hong Kong and South Korea.
 As Argentina shows, however, catch-up growth is
not guaranteed.
 Sustained Growth

 Some countries experience positive and

relatively steady growth rates over 50- ,
100-, and even 200-year periods
 Examples
 United Kingdom, United States, France, and Spain
Drivers of Sustained Growth

 Physical capital  Can’t. Why?

accumulation?  Diminsihing
marginal product
 Increasing H ?  Can’t. Why?
 Diminsihing MP of
 labour and skills

 Technological  Yes !
change ?
The Real Price of Light

Exhibit 21.9
© 2015 Pearson Education, Ltd.
 Technological Change

 is exponential
 The rate of increase is approximately constant
 Moore’s Law p.505

 Because new innovations and

technologies
 build on the existing stock of knowledge
 are not subject to diminishing returns

 Technological advances lead to

sustained economic growth
Explaining Productivity Growth

Exhibit 21.10
© 2015 Pearson Education, Ltd.
Explaining Productivity Growth

Exhibit 21.10
© 2015 Pearson Education, Ltd.
 Explaining Productivity Growth

The contribution of K and H is relatively steady at 0.9% - 1.2%

The contribution of technology has varied from 0.45% to 2.4%
Exhibit 21.11
© 2015 Pearson Education, Ltd.
Thinking Problem

 Why are you so much more prosperous

than your great-great-grandparents were?
 Answer:
 Because of steady technological change
 In most decades, technology accounts for the bulk of
growth in U.S. GDP per worker
 Caveat: If we understate the contribution of physical or
human capital to GDP, the contribution of technology
may be exaggerated.
EXPLAINING INEQUALITY
Inequality Around the World

 Income per capita depends on what

fraction of population works
 The age structure of the population
 Labour participation rates

 Income per worker measures well

differences in productivity
GDP
Income per worker =
Number of people employed
 GDP per Capita vs. per Worker
in 2010 (PPP Method)
GDP per GDP per
Ranking Country
Capita Worker
1 Qatar 142,876 182,297
2 Luxembourg 95,537 101,180
3 United Arab Emirates 70,899 91,694
6 Norway 59,946 94,863
10 United States 46,613 82,359
87 Peru 9,012 13,931
182 Burundi 397 770
183 Zimbabwe 368 606
184 Dem. Rep. of Congo 282 628
© 2015 Pearson Education, Ltd.
Income per Worker in 2010
(PPP-adjusted 2005 constant dollars)

Exhibit 20.3
© 2015 Pearson Education, Ltd.
 Real GDP per capita vs. Productivity
in 2010 (PPP adjusted 2005 dollars)
70
Real GDP per hours worked

Norway
60 Luxembourg
50 United States

40
30
20
10 Mexico Chile
Russia
0
0 20,000 40,000 60,000 80,000
© 2015 Pearson
Education, Ltd.
Real GDP per capita
Thinking Problem

 Why is the average American so much

richer than the average Indian?
Explaining Inequality

Exhibit 20.12
© 2015 Pearson Education, Ltd.
 USA vs. India

 Income per worker in the USA is actually 9

times larger than in India
 82,359/9,010 ~9
 If an Indian worker had the same technology
as an US worker than income per worker
 in the USA would be 3.5 times larger than in India
 82,359/24,071 ~ 3.5
 in India would increase threefold
 24,071/9,010 ~ 2.7
Thinking Problem

 Why is the average American so much

richer than the average Indian?
 Mostly because of better technology in
the United States
 Partly because of more physical and
human capital available in the US
Key Ideas
 Productivity
 Physical, human capital
 Law of diminishing returns
 Technology, knowledge, efficiency
 Technological change is exponential
 Income per capita, income per worker
 Aggregate production function
 Total efficiency units of labor
 Catch up growth
 Drivers of sustained growth
 Drivers of productivity growth
 Explaining inequality around the world
To do for next seminar

 Read ch.24 of Acemoglu et al. (2016).

 Consider the thinking problems on
moodle