(BQ) Part 1 book Marcoeconomics has contents: The principles and practice of economics, economic methods and economic questions; economic methods and economic questions; aggregate incomes, the wealth of nations - defining and measuring macroeconomic aggregates,...and other contents.
Find more at www.downloadslide.com Macroeconomics For these Global Editions, the editorial team at Pearson has collaborated with educators across the world to address a wide range of subjects and requirements, equipping students with the best possible learning tools This Global Edition preserves the cutting-edge approach and pedagogy of the original, but also features alterations, customization, and adaptation from the North American version Global edition Global edition Global edition Acemoglu • Laibson • List Macroeconomics Daron Acemoglu • David Laibson • John A List This is a special edition of an established title widely used by colleges and universities throughout the world Pearson published this exclusive edition for the benefit of students outside the United States and Canada If you purchased this book within the United States or Canada, you should be aware that it has been imported without the approval of the Publisher or Author Pearson Global Edition Acemoglu_1292080639_mech.indd 04/03/15 8:59 PM Find more at www.downloadslide.com MyEconLab Provides the Power of Practice ® Optimize your study time with MyEconLab’s tutorial and assessment solution that personalizes the learning experience, giving students the practice and immediate feedback they need Study Plan The Study Plan shows you the sections you should study next, gives easy access to practice problems, and provides you with an automatically generated quiz to prove mastery of the course material Unlimited Practice As you work each exercise, instant feedback helps you understand and apply the concepts Many Study Plan exercises contain algorithmically generated values to ensure that you get as much practice as you need Learning Resources Study Plan problems link to learning resources that further reinforce concepts you need to master • Help Me Solve This learning aids help you break down a problem much the same way an instructor would during office hours Help Me Solve This is 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weekly, we find the latest microeconomic and macroeconomic news stories, post them, and write auto-graded multi-part exercises that illustrate the economic way of thinking about the news Interactive Homework Exercises Participate in a fun and engaging activity that helps promote active learning and mastery of important economic concepts Pearson’s experiments program is flexible and easy for instructors and students to use For a complete list of available experiments, visit www.myeconlab.com A02_ACEM0635_01_GE_FM.indd 17/03/15 7:30 PM Find more at www.downloadslide.com The Pearson Series in Economics Abel/Bernanke/Croushore Macroeconomics* Fort Sports Economics Acemoglu/Laibson/List Economics* Froyen Macroeconomics Bade/Parkin Foundations of Economics* Fusfeld The Age of the Economist Berck/Helfand The Economics of the Environment Gerber International Economics* Bierman/Fernandez Game Theory with Economic Applications González-Rivera Forecasting for Economics and Business Blanchard 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Econversations: Today’s Students Discuss Today’s Issues Weil Economic Growth Williamson Macroeconomics *denotes MyEconLab titles Visit www.myeconlab.com to learn more A02_ACEM0635_01_GE_FM.indd 17/03/15 7:30 PM Find more at www.downloadslide.com Global Edition MACROECONOMICS Daron Acemoglu Massachusetts Institute of Technology David Laibson Harvard University John A List University of Chicago Boston Columbus Indianapolis New York San Francisco Hoboken Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo Preface A02_ACEM0635_01_GE_FM.indd 17/03/15 7:30 PM Find more at www.downloadslide.com Vice President, Business Publishing: Donna Battista Executive Acquisitions Editor: Adrienne D’Ambrosio Executive Development Editor: Mary Clare McEwing Editorial Assistant: Courtney Turcotte Senior Acquisitions Editor, Global Editions: Steven Jackson Project Editor, Global Editions: Suchismita Ukil Vice 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Melissa Honig Digital Content Team Lead: Noel Lotz Digital Content Project Lead: Courtney Kamauf Full-Service Project Management and Composition: S4Carlisle Publishing Services Interior Designer: Jonathan Boylan Cover Designer: Lumina Datamatics Pvt Ltd Acknowledgments of third-party content appear on the appropriate page within the text and on pp 411–412, which constitutes an extension of this copyright page Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsonglobaleditions.com © Pearson Education Limited 2016 The rights of Daron Acemoglu, David Laibson, and John A List to be identified as the authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988 Authorized adaptation from the United States edition, entitled Macroeconomics, 1st edition, ISBN 978-0-321-38395-2, by Daron Acemoglu, David Laibson, and John A List, published by Pearson Education, Inc © 2015 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a license permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS All trademarks used herein are the property of their respective owners The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners ISBN 10: 1-292-08063-9 ISBN 13: 978-1-292-08063-5 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library 10 14 13 12 11 Typeset in by S4Carlisle Publishing Services Printed and bound by CPI Digital in the United Kingdom A02_ACEM0635_01_GE_FM.indd 17/03/15 7:30 PM Find more at www.downloadslide.com Dedication With love for Asu, Nina, and Jennifer, who inspire us every day A02_ACEM0635_01_GE_FM.indd 17/03/15 7:30 PM Find more at www.downloadslide.com About the Authors Daron Acemoglu is Elizabeth and James Killian Professor of Economics in the Department of Economics at the Massachusetts Institute of Technology He has received a B.A in economics at the University of York, 1989; M.Sc in mathematical economics and econometrics at the London School of Economics, 1990; and Ph.D in economics at the London School of Economics in 1992 He is an elected fellow of the National Academy of Sciences, the American Academy of Arts and Sciences, the Econometric Society, the European Economic Association, and the Society of Labor Economists He has received numerous awards and fellowships, including the inaugural T W Shultz Prize from the University of Chicago in 2004, the inaugural Sherwin Rosen Award for outstanding contribution to labor economics in 2004, Distinguished Science Award from the Turkish Sciences Association in 2006, and the John von Neumann Award, Rajk College, Budapest in 2007 He was also the recipient of the John Bates Clark Medal in 2005, awarded every two years to the best economist in the United States under the age of 40 by the American Economic Association, and the Erwin Plein Nemmers prize awarded every two years for work of lasting significance in economics He holds Honorary Doctorates from the University of Utrecht and Bosporus University His research interests include political economy, economic development and growth, human capital theory, growth theory, innovation, search theory, network economics, and learning His books include Economic Origins of Dictatorship and Democracy (jointly with James A Robinson), which was awarded the Woodrow Wilson and the William Riker prizes, Introduction to Modern Economic Growth, and Why Nations Fail: The Origins of Power, Prosperity, and Poverty (jointly with James A Robinson), which has become a New York Times bestseller David Laibson is the Robert I Goldman Professor of Economics at Harvard University He is also a member of the National Bureau of Economic Research, where he is Research Associate in the Asset Pricing, Economic Fluctuations, and Aging Working Groups His research focuses on the topic of behavioral economics, and he leads Harvard University’s Foundations of Human Behavior Initiative He serves on several editorial boards, as well as the boards of the Health and Retirement Study (National Institutes of Health) and the Pension Research Council (Wharton) He serves on Harvard’s Pension Investment Committee and on the Academic Research Council of the Consumer Financial Protection Bureau He is a recipient of a Marshall Scholarship and a Fellow of the Econometric Society and the American Academy of Arts and Sciences He is also a recipient of the TIAA-CREF Paul A Samuelson Award for Outstanding Scholarly Writing on Lifelong Financial Security Laibson holds degrees from Harvard University (A.B in Economics, Summa), the London School of Economics (M.Sc in Econometrics and Mathematical Economics), and the Massachusetts Institute of Technology (Ph.D in Economics) He received his Ph.D in 1994 and has taught at Harvard since then In recognition of his teaching, he has been awarded Harvard’s Phi Beta Kappa Prize and a Harvard College Professorship A02_ACEM0635_01_GE_FM.indd 17/03/15 7:30 PM Find more at www.downloadslide.com John A List is the Homer J Livingston Professor in Economics at the University of Chicago, and Chairman of the Department of Economics List received the Kenneth Galbraith Award, Agricultural and Applied Economics Association, 2010 He is a Member of the American Academy of Arts and Sciences, 2011; Editor, Journal of Economic Perspectives; Associate Editor, American Economic Review; and Associate Editor, Journal of Economic Literature His research focuses on questions in microeconomics, with a particular emphasis on the use of experimental methods to address both positive and normative issues Much of his time has been spent developing experimental methods in the field to explore economic aspects of environmental regulations, incentives, preferences, values, and institutions Recently, he has focused on issues related to the economics of charity, exploring why people give, plus optimal incentive schemes for first-time as well as warm-list donors A02_ACEM0635_01_GE_FM.indd About the Authors 17/03/15 7:30 PM Find more at www.downloadslide.com A02_ACEM0635_01_GE_FM.indd 17/03/15 7:30 PM Find more at www.downloadslide.com The physical capital stock of an economy is the value of equipment, structures and other non-labor inputs used in production An economy with better technology uses its labor and capital more efficiently and achieves higher productivity different, we can aggregate them into a single measure and obtain the physical capital stock of the economy using their dollar value Workers will be more productive when the economy has a bigger physical capital stock, enabling each worker to work with more (or better) equipment and structures (3) Technology: An economy with better technology uses its labor and capital more efficiently and thus achieves higher productivity We will see below that an economy can have better technology either because it uses superior knowledge in production (for example, new manufacturing techniques not available to other economies) or because it organizes production more efficiently 6.1 6.2 6.3 The Aggregate Production Function Human capital, physical capital, and technology each play a part in determining how productive workers in an economy are The aggregate production function is our tool for understanding how these three ingredients all come together to generate GDP in an economy In the previous chapter, we saw how we can aggregate tens of thousands of commodities into a single measure of GDP For our analysis here, we can go one step further Once we have made Human capital, physical capital, and the simplification of aggregating everything into GDP, we can technology each play a part in deterjust think of GDP as if it were a single commodity Even though this simplification ignores the composition of GDP, it allows us to mining how productive workers in more clearly look at what determines the level of GDP, which is an economy are our main purpose in this chapter The advantage of looking at GDP in this way is that once we start thinking of the world in terms of a single commodity, we can study the aggregate production function of the economy, which describes the relationship between GDP and its various inputs This is similar to how we study the relationship between the output of a single firm and the inputs that it uses For example, if we wanted to understand how much corn a farm produces, we would first specify the relationship between total corn production and its key inputs, for example, the number of workers on the farm and the equipment that the farm uses A key concept in our study of the aggregate production function is factors of production You will recall from the previous chapter that factors of production are the inputs to the production process—goods or services purchased in the market for producing other goods, in this case for producing GDP To understand a nation’s output, we will look at a production function that describes how the factors of production are combined to produce GDP But differently from the case in which we study a single firm, our focus is not specific commodities, such as T-shirts or iPhones, but all of GDP, and we therefore refer to this function as the aggregate production function An aggregate production function describes the relationship between The aggregate production function is useful for understanding not only how GDP is the aggregate GDP of a nation and determined but also why productivity varies across countries its factors of production Labor Total efficiency units of labor is the product of the total number of workers in the economy and the average human capital of each worker M06_ACEM0635_01_GE_CH06.indd 155 The first and most important factor of production is labor A nation can increase output by employing more workers For example, more workers can be deployed for tilling the soil and harvesting corn Remember, though, that not all workers are the same Some will have greater human capital than others and will be able to produce more output or economic value (and this is the reason why, as we have seen, human capital is a major determinant of productivity) Such differences in workers’ human capital make looking at the total number of workers in an economy a poor indicator of how much the economy can produce Instead, we need to know the total efficiency units of labor Total efficiency units of labor is defined as the product of the total number of workers and the average human capital (efficiency) of (employed individuals) workers For example, suppose a computer science graduate can perform the same job as two high school graduates Then, it would be natural to give twice the weight to her labor than that of high school graduates Now applying the same idea more broadly, we can compute the total efficiency units of labor, denoted by H, as the Section 6.2 | Productivity and the Aggregate Production Function 155 17/03/15 1:57 PM Find more at www.downloadslide.com product of the total number of workers in the economy, L, and the average efficiency or human capital of workers, h Thus, we write: 6.1 H = L × h This equation implies that the total efficiency units of labor in the economy can be increased either if more workers take part in the production process (for example, because employment increases) or if each worker becomes more productive Acquiring more skills through formal schooling is one way for a worker to increase productivity 6.2 6.3 Physical Capital and Land The second major factor of production is physical capital, typically denoted by K (corresponding to the first letter of “Kapital,” the German spelling of capital) When an economy has more physical capital, or equivalently, a greater physical capital stock, its workers can work with more and better equipment and structures, and thus the economy will produce more GDP A third factor of production is land For example, if we think of an economy in the eighteenth century, land and other natural resources would be the key factors of production Yet other factors of production include natural resources and the entrepreneurial talent of the economy (the skills and capabilities of its entrepreneurs and businesspeople) To simplify the discussion, we focus only on physical capital and labor (specifically, total efficiency units of labor) When we so, the value of land and natural resources can be included in the physical capital stock (the same way that the value of buildings is) We will return to the role of entrepreneurial talent in the context of our discussion of technology below Representing the Aggregate Production Function Let us represent the aggregate production function as follows: Y = A × F(K,H) When we read an expression like the one above aloud, we say, “Y is a function of K and H.” We read our notation as follows: Y stands for GDP K is the physical capital stock of the nation H is the efficiency units of labor that the economy uses in production The function F signifies that there is a relationship between physical capital, labor, and GDP In particular, GDP is generated through a combination of physical capital and the efficiency units of labor A is an index of technology A higher A implies that the economy produces more GDP with the same level of physical capital stock and total efficiency units of labor We discuss the role of technology in greater detail below As we have already emphasized, this aggregate production function is similar to the production function of an individual firm for producing a specific type of commodity In particular: The Law of Diminishing Marginal Product states that the marginal contribution of a factor of production to GDP diminishes when we increase the quantity used of that factor of production (holding all others constant) 156 Chapter M06_ACEM0635_01_GE_CH06.indd 156 (1) Just like the production function of a specific firm, the aggregate production function will show that GDP is increasing in both physical capital and labor—put differently, more is better Holding labor constant, if we have a greater physical capital stock, we will be able to produce more GDP Holding physical capital constant, if we have more labor, we will also be able to produce more GDP (2) The aggregate production function is also subject to the Law of Diminishing Marginal Product (which is related to our discussion of diminishing marginal benefit in Chapter 4) The Law of Diminishing Marginal Product states that the marginal contribution of a factor of production to GDP diminishes when we increase the quantity used of that factor of production (holding all other factors of production constant) We can illustrate the aggregate production function graphically by holding the total efficiency units of labor constant, as in Exhibit 6.7, or by holding the physical capital stock constant, as in Exhibit 6.8 Let’s start with Exhibit 6.7 | Aggregate Incomes 17/03/15 1:57 PM Find more at www.downloadslide.com Exhibit 6.7 The Aggregate Production Function with Physical Capital Stock on the Horizontal Axis (with the Total Efficiency Units of Labor Held Constant) 6.1 Y Holding the total efficiency units of labor constant, the aggregate production function shows the relationship between the physical capital stock and GDP in the economy As the physical capital stock increases, so does GDP But the relationship becomes less and less steep as the physical capital stock of the economy increases because of the Law of Diminishing Marginal Product For the same one-unit increase in the physical capital stock, the increase in GDP is greater at point A (with lower physical capital stock) than at point B (with greater physical capital stock) 6.2 B A 6.3 One unit increase in physical capital stock One unit of physical capital stock K = Physical capital stock This exhibit shows both the increasing relationship between physical capital and output, and the Law of Diminishing Marginal Product In particular, the marginal contribution of an additional unit of physical capital to output—how much output increases as a result of a unit increase in the physical capital stock—is decreasing in the total physical capital stock We see this by comparing the increase in output for a unit increase in physical capital stock at two different points of the aggregate production function in Exhibit 6.7 Consider a unit increase close to the origin (point A) When there is less physical capital in the economy, the corresponding increase in output is large When we have the same unit increase farther to the right, corresponding to more physical capital (point B), the resulting increase in output is smaller, as shown by the smaller vertical increase at B than at A This visual difference captures the Law of Diminishing Marginal Product Exhibit 6.7 holds the efficiency units of labor, H, constant and looks at the relationship between the physical capital stock and GDP Exhibit 6.8 does the opposite, holding the physical capital stock, K, constant and looking at the relationship between the efficiency units of labor of the economy and GDP This relationship also satisfies the Law of Diminishing Marginal Product Exhibit 6.8 The Aggregate Production Function with the Efficiency Units of Labor on the Horizontal Axis (with Physical Capital Stock Held Constant) Holding the physical capital stock constant, the aggregate production function shows the relationship between the total efficiency units of labor and GDP Once again, as the total efficiency units of labor increase, so does GDP, but consistent with the Law of Diminishing Marginal Product, the relationship becomes less and less steep as the total efficiency units of labor increase Y B A One unit increase in efficiency units of labor One unit of physical capital stock M06_ACEM0635_01_GE_CH06.indd 157 H = Efficiency units of labor Section 6.2 | Productivity and the Aggregate Production Function 157 17/03/15 1:57 PM Find more at www.downloadslide.com 6.3 6.1 The Role and Determinants of Technology 6.2 We now discuss how technology affects the aggregate production function and the factors that influence the level of technology of an economy 6.3 Technology A third determinant of GDP is technology The aggregate production function specifies that technology is a way of summarizing the relationship between the factors of production and GDP A better technology means that the economy can generate more output from the same set of inputs Exhibit 6.9 shows the implications of better technology for the aggregate production function: again holding the efficiency units of labor, H, constant, the relationship between GDP and the physical capital stock shifts left Therefore, for every level of the e fficiency units of labor, a better technology implies that the economy will produce more GDP Our study of the aggregate production function thus clarifies why productivity depends on human capital, physical capital, and technology Holding the total number of workers constant, greater human capital, a larger stock of physical capital, and better technology will all increase GDP Because the total number of workers (and hours of work per worker) is constant, this also corresponds to an increase in productivity Dimensions of Technology Technology, as we have defined it, is rather broad, and in fact has two very distinct components The first is knowledge Today, we know how to produce many new goods, such as smart phones and tablets, which were not available previously In addition, this knowledge also enables us to perform certain tasks more efficiently For example, when you use a computer for writing an essay or doing computations for a class, you are making use of the computing power, which comes from the knowledge that society has acquired and has applied to its production process Part of this knowledge is in the human capital of the workers: workers today can perform a range of tasks more productively than their grandparents could But an important part of this knowledge is embodied in the physical capital stock of firms: the computers that firms are using are part of the physical capital stock of the economy Nevertheless, there is also a sense in which technology is different from the physical capital stock of the economy Your great-grandparents, however much they may have wished to pay for a computer, would not have been able to so, because computers were not yet commercially sold Your grandparents would have had to pay an enormous price for a computer with fewer capabilities than the one you are using now, and it would have likely been a Exhibit 6.9 The Shift in the Production Function Resulting from More Advanced Technology As technology improves, the aggregate production function shifts upwards, indicating that with the same amount of physical capital stock and total efficiency units of labor, more output can be produced In this exhibit, the total efficiency units of labor are held constant, and for a given level of physical capital stock, the economy with more advanced technology has a higher level of GDP Y Economy uses more advanced technology Economy uses less advanced technology K = Physical capital stock 158 Chapter M06_ACEM0635_01_GE_CH06.indd 158 | Aggregate Incomes 17/03/15 1:57 PM Find more at www.downloadslide.com LETTING THE DATA SPEAK 6.1 Moore’s Law A long-term trend of rather remarkable regularity in the development of computer microprocessors has been observed since 1965 It’s dubbed Moore’s Law after Intel cofounder Gordon Moore, who predicted in that year that the number of transistors on a chip would double approximately every years.2 The number of transistors is a key determinant of how fast a computer processor is So roughly speaking, Moore’s Law implies that computer processor power should double approximately every 2 years So far, this seems to have been borne out by developments in computer technology, as illustrated in Exhibit 6.10 Several other measures of technological advances in computing have also behaved according to Moore’s Law For example, the number of pixels in digital cameras and RAM storage capacity have also doubled every years or so, while power consumption of computer nodes and hard disc storage costs appear to have been halved approximately every years Naturally, there is nothing predetermined about the relationship between time and progress in technology 6.2 that would make this into an actual “law.” This progress results from the investments of several companies in new computer technologies, which are in turn driven by the profitability of these investments It also relies on government support for university and private research and on the ability of the United States and other advanced and developing nations to attract increasing numbers of young, talented students into science, engineering, and related fields Things can change in the future, halting this rapid progress in technology Fewer college students could choose to major in science and engineering in the future, or governments could decide to limit or even stop their support for private or university research, weakening incentives for further technological advances Moreover, even without a major cutback in funding or a change in the profitability of research in this area, the rate of advance may slow down from its current breakneck pace Nevertheless, the relationship so far has been very accurate and, assuming it continues in the years to come, the implications for lives are enormous 6.3 Transistor 1,000,000,000 count 100,000,000 10,000,000 1,000,000 100,000 10,000 1,000 1970 1975 1980 1985 1990 1995 2000 2005 Year of introduction Exhibit 6.10 Moore’s Law Gordon Moore predicted in 1965 that the speed of computer processors would improve steadily This has turned out to be a very accurate prediction, with the number of transistors packed in a computer chip doubling approximately every years This remarkable trend, which has come to be known as Moore’s Law, now symbolizes the sustained technological improvements of our era Source: Intel, “Moore’s Law: Raising the Bar,” Backgrounder (2005), available at: http://www.bandwidthco.com/ whitepapers/hardware/cpu/moore/Moores%20Law%20-%20Raising%20the%20Bar.pdf Research and development (R&D) refers to the activities directed at improving scientific knowledge, generating new innovations, or implementing existing knowledge in production in order to improve the technology of a firm or an economy M06_ACEM0635_01_GE_CH06.indd 159 giant machine rather than the small notebooks that many of you are using Thus advances in technology—in this specific instance, in computer technology—directly increase the number of tasks we can perform and the speed at which we can accomplish them Advances in technology sometimes happen by chance, but more often, they result from the purposeful, optimizing decisions of economic agents For example, society achieves such advances with research and development (R&D), which involves a wide range of activities like research on new scientific ideas in universities and private labs, research directed at finding Section 6.3 | The Role and Determinants of Technology 159 17/03/15 1:57 PM Find more at www.downloadslide.com 6.1 6.2 6.3 new ways of applying science to production on the factory floor, and development activities geared at commercializing e xisting knowledge and products R&D is a major activity in the United States economy Almost 1.41 million people worked as researchers in 2007 (the most recent year for which this information is available), and $430 b illion—2.77 percent of total GDP—was spent on research and development Of this amount, about $270 billion was spent by businesses, while the remaining portion was spent by the U.S government, universities, and other institutions Economists often use the term technology more broadly than to describe advances in our knowledge about production processes To see this, imagine two economies In one, the allocation of resources is determined by the market, and in the other, resources are allocated randomly across individuals and firms As a specific example, say that both of these economies have two types of workers, economics professors and basketball players, and two types of tasks, teaching and basketball Advances in technology sometimes The first economy relies on the market for allocating workers to happen by chance, but more often, tasks Basketball players who are better at basketball than teaching will play basketball, and economics professors will the teachthey result from the purposeful, ing In the second, allocation takes place randomly Suppose that optimizing decisions of economic economics professors are assigned to the basketball playing and agents the basketball players the teaching There are no differences in the knowledge available for production between the two economies, and both have the same human capital But the first economy will be much more successful (especially in basketball), and will produce more output (more and better basketball and perhaps even better teaching) What is the difference between the two economies? This difference has to with the Efficiency of production refers efficiency of production—the ability of society to produce the maximal amount of outto the ability of an economy to put at a given cost or for given levels of the factors of production and knowledge When produce the maximal amount the economy is able to increase the efficiency of production, there will be a shift in the of output from a given amount aggregate production function similar to that shown in Exhibit 6.9 We therefore include of factors of production and efficiency of production as part of our definition of technology because it captures the difknowledge ferences in how much output an economy can generate with given amounts of inputs The importance of technology for GDP is the reason why we include A and represented the aggregate production function as: A × F(K,H) LETTING THE DATA SPEAK Efficiency of Production and Productivity at the Company Level Economist James Schmitz Jr studied the experience of the iron ore industries in the United States and Canada in the face of competition from Brazilian producers.3 His findings provide a particularly clear illustration of how changes in the organization of firms can lead to improvements in the efficiency of production—or “technology"— and thus increase productivity significantly Schmitz documents that productivity—for example, measured as output of iron ore per hour—was constant since at least 1970 in the Canadian and the U.S iron ore industries when they faced little foreign competition In the early 1980s, however, Brazilian producers entered the U.S market and started to deliver iron ore to Chicago and other central markets Schmitz shows that in the course of the next decade, productivity in the U.S and Canadian iron ore industries, which had been flat for a long time, doubled He shows that this was not 160 Chapter M06_ACEM0635_01_GE_CH06.indd 160 due to more intensive use of capital or materials, nor was it driven by the use of new production techniques Rather, it resulted from a significant reorganization of production Iron ore production plants were heavily unionized—a fact that, according to Schmitz, prevented the plants from efficiently allocating labor across different tasks For example, despite industry studies suggesting that there was an excess number of repair workers for a large variety of equipment, union contracts did not permit reduction in repair staff Following the increase in competition, these work rules were changed, enabling a more productive use of labor Schmitz provides a variety of additional evidence showing that these and other changes in work rules allowed a more flexible allocation of labor across tasks and therefore better utilization of equipment, resulting in the dramatic increase in productivity | Aggregate Incomes 17/03/15 1:58 PM Find more at www.downloadslide.com Greater A corresponds to better technology and increases GDP for given levels of efficiency units of labor and physical capital stock, which shifts the aggregate production function left, as shown in Exhibit 6.9 But note that A is not a factor of production Although it designates the technology available to the economy, it does not correspond to an input that the producer can purchase in the marketplace 6.1 6.2 Entrepreneurship A particularly important reason why efficiency of production and productivity might differ across economies relates to entrepreneurship As we discuss in greater detail in Chapter 8, various factors might influence whether the individuals with a comparative advantage for entrepreneurship become entrepreneurs When they fail to so, the efficiency of production of an economy is lower—in the same way as the mismatch between basketball players and economics teachers, though perhaps more importantly 6.3 LETTING THE DATA SPEAK Monopoly and GDP When Mexico entered the North American Free Trade Agreement, NAFTA, with the United States in 1994, many economists predicted that Mexico’s economy would grow rapidly But in the first 15 years after signing NAFTA, Mexico’s growth was much less than most analysts expected Monopolies and barriers against the entry of new companies are just some of the reasons why the country has not achieved more significant growth Consider the telecommunications sector in Mexico, which was for a long time operated as a state monopoly It subsequently was privatized, but turned into a private ICT 12 expenditure (% of GDP) 10 monopoly under the ownership of Carlos Slim, who has now become one of the richest people in the world In contrast, the telecommunications sector in the United States is very competitive, with many firms competing in both wireless and broadband The Mexican telecommunications sector not only charges higher prices than other countries but also invests less than other comparable countries, as shown in Exhibit 6.11 Removing monopolies and entry barriers that prevent the efficient allocation of resources is one important way of increasing GDP Singapore Colombia Peru Brazil China Costa Rica Chile Japan United States South Korea Argentina Mexico 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 Income per capita purchasing power parity Exhibit 6.11 Underinvestment in Information and Communication Technology in Mexico Relative to Countries with Comparable Income Monopolies and barriers against the entry of new companies often discourage investment and slow down technological progress For example, Mexico, where the telecommunications sector is monopolized, invests in information and communication technology less than other countries with similar income per capita Source: World Bank DataBank M06_ACEM0635_01_GE_CH06.indd 161 Section 6.3 | The Role and Determinants of Technology 161 17/03/15 1:58 PM Find more at www.downloadslide.com 6.1 6.2 Evidence-Based Economics Q: Why is the average American so much richer than the average Indian? T o understand the variation in productivity and income per worker between the United States and India (and other countries), it is useful to focus on three factors: human capital, physical capital, and technology To see the relative importance of any one of these factors in explaining differences in income (GDP) per worker across countries, we can compare a country’s actual income per worker with what would be if the country had access to the same human capital, physical capital stock, or technology of another country This is exactly what we in Exhibit 6.12, specifically with technology Using data on education attainment (a key aspect of human capital) and employment, we calculate the efficiency units of labor Column records the average years of schooling per worker of each country It shows that most countries have significantly lower levels of average schooling than the United States Then, using data on investment over several decades, we calculate the physical capital stock for each country Column shows the ratio of the physical capital stock per worker of each country relative to the physical capital stock per worker in the United States Most countries have a significantly lower physical capital stock per worker than the United States (but there are also countries like Norway, not shown in the exhibit, that have higher levels than the United States) Using estimates of the shape of the aggregate production function (we provide details of this estimation in the appendix to this chapter), we can then see how the efficiency units of labor and physical capital stock are translated into income per worker Comparing these contributions of human capital and physical capital with actual income per worker (recorded in column of Exhibit 6.12), we can then infer how much of a contribution technology makes to income per worker Specifically, any GDP that cannot be accounted for by physical capital and labor, we assume to be accounted for by technology Given the estimates of the aggregate production function, we can now compute what the income level of all of these countries would have been if they had had access to exactly the same technology as the United States (using their actual efficiency units of labor and physical capital stock) This information is recorded in column of the exhibit The difference 6.3 Exhibit 6.12 The Contribution of Human Capital, Physical Capital, and Technology to Differences in Income per Worker Source: Data from Penn World Table (Alan Heston, Robert Summers, and Bettina Aten, Penn World Table Version 7.1) 162 Chapter M06_ACEM0635_01_GE_CH06.indd 162 Country (1) United States United Kingdom South Korea Spain Mexico Brazil China India Ghana Afghanistan Dem Rep of the Congo Income per Worker in 2010 Average Years of Schooling (2) 82,359 67,025 54,315 54,539 27,625 15,975 12,961 9,010 4,928 3,980 628 (3) 13.1 9.8 11.8 10.4 9.1 7.5 8.2 5.1 7.1 4.2 3.5 % of U.S Physical Capital Stock per Worker in 2010 (4) 100.0 65.8 87.7 83.9 33.5 16.9 14.9 8.9 4.2 3.7 0.8 Income per Worker If Technology Were at U.S Level (5) SAME 61,548 74,496 68,684 47,725 35,045 34,881 24,071 21,502 16,818 9,625 | Aggregate Incomes 17/03/15 1:58 PM Find more at www.downloadslide.com 6.1 6.2 between actual incomes and these hypothetical numbers illustrates the contribution of technology The exhibit reveals some powerful facts Consistent with the patterns we have already seen in Exhibits 6.1–6.3, income per worker in the United States is about times that in India (82,359/9,010 ≃ 9) We also see that Indians have average years of schooling of 5.1 compared to 13.1 in the United States and that the physical capital stock per worker in India is about percent of that of the United States So how much would a typical Indian worker produce with this amount of human capital and physical capital if he, hypothetically, had access to the U.S level of technology? Column shows that the answer is $24,071 This implies that the hypothetical income per Indian worker if India’s technology were at the U.S level is nearly times as much as its current income per worker: 24,071/9,010 ≃ 2.7, suggesting a sizable impact of technology differences If, in addition, India also increased its human capital and physical capital per worker to U.S levels, it would increase its income per worker to the U.S level (This is by construction: if India has the same level of human capital and physical capital per worker, and the same technology as the U.S., it would have the same income per worker as the U.S.) In the Indian case this would correspond to an increase by another 3 ½ times (82,359/24,071 ≃ 3.5) Recall, however, that the technology differences that appear so important (roughly as important as total efficiency units of labor and physical capital combined) are not just differences in the knowledge available to the economy and to firms for production They also reflect differences in the efficiency of production, as our example of economics professors and basketball players illustrated, and if there is any mismeasurement in factors of production, this will appear as technology differences For example, in practice, human capital across countries differs not only because of average years of schooling but also because of major differences in the quality of schooling If rich countries have a systematically higher quality of schooling, our methodology can lead to exaggerated technology differences 6.3 Question Answer Data Caveat Why is the average merican so much richer A than the average Indian? Differences in total efficiency units of labor and physical capital are important If India had access to the same technology as the United States (including differences in the efficiency of production), its income (or GDP) per worker would be $24,071 instead of $9,010, almost times as high Increasing India’s total efficiency units of labor and physical capital to U.S levels would increase its income per worker by another 3½ times Cross-country data on PPP-adjusted income per worker, schooling, and investment Technology differences include differences in the efficiency of production and may also reflect mismeasurement M06_ACEM0635_01_GE_CH06.indd 163 Section 6.3 | The Role and Determinants of Technology 163 17/03/15 1:58 PM Find more at www.downloadslide.com Summary Income per capita, defined as aggregate income or gross domestic product (GDP) divided by total population, varies greatly across countries, with some nations such as the United States and Norway having more than 40 times the income per capita of some other nations such as Afghanistan, Niger, and the Democratic Republic of Congo Income (or GDP) per capita across countries can be compared using exchange-rate-based measures, which rely on current exchange rates, or purchasing power parity-based measures, which compare estimates of the cost of the representative bundle of commodities in each country The latter tends to be more reliable as it more appropriately captures differences in relative prices across countries, and is not subject to fluctuations resulting from changes in exchange rates Though income per capita omits a wealth of other important information about a country (health, schooling, inequality, and poverty), it provides a good summary of prosperity and is typically correlated with higher life expectancy, greater schooling, and lower poverty The aggregate production function links the GDP of a nation to its total efficiency units of labor, physical capital stock, technology, and efficiency of production Greater efficiency units of labor and physical capital, as well as better technology and efficiency of production, increase GDP Though the total efficiency units of labor and physical capital stock matter a great deal for GDP, the most important determinant of cross-country differences in income (or GDP) per worker appears to be differences in technology and the efficiency of production Key Terms income per capita or GDP per capita p 147 purchasing power parity (PPP) p 148 income (or GDP) per worker p 150 productivity p 151 one dollar a day per person poverty line p 152 164 Chapter M06_ACEM0635_01_GE_CH06.indd 164 human capital p 154 physical capital p 154 physical capital stock p 155 technology p 155 aggregate production function p 155 total efficiency units of labor p 155 Law of Diminishing Marginal Product p 156 research and development (R&D) p 159 efficiency of production p 160 | Aggregate Incomes 17/03/15 1:58 PM Find more at www.downloadslide.com Questions Select questions are available in MyEconLab for practice and instructor assignment Suppose you are comparing the income per capita in the United States and Ghana You first convert the values into U.S dollars using the current exchange rate between the U.S dollar and the Ghanaian cedi You also convert both values to U.S dollars using the purchasing power parityadjusted exchange rate Which measure is likely to give you a more accurate picture of the living standards in both countries? Explain your answer What are the disadvantages of using Big Macs to measure purchasing power parity? Suppose that country A has higher income per capita than country B Explain why this does not imply that most citizens of country A have higher income than most citizens of country B Try to construct an example in which both countries have 10 citizens to demonstrate this point A country with a higher GDP must have a GDP per capita that is higher than that of a country with a lower GDP Is this statement true or false? What is the correlation between income per capita and welfare measures like absolute poverty and life expectancy? What does this suggest about income per capita as a measure of welfare? Suppose that there are two factors of production—physical capital and labor Given the amount of physical capital stock, explain how additional output produced depends on the existing level of employment What is productivity? Why does it vary across countries? What are the two components of technology? What are factors of production? What does the aggregate production function describe? 10 Use an expression to explain how education improves the efficiency units of labor in an economy 11 Use the following diagram to explain the relationship between a country’s physical capital stock and GDP Y K = Physical capital stock 12 Explain the difference between the terms “physical capital” and “human capital.” 13 Explain what distinguishes physical capital from natural resources 14 How increases in technology affect the aggregate production function? 15 What does Moore’s Law state? Is Moore’s Law borne out by historical data? 16 Why is the average American so much richer than the average Indian? 17 What are the problems of only focusing on income per capita? Problems Select problems are available in MyEconLab for practice and instructor assignment Problems marked update with real-time data You read a newspaper report that compares wages paid to employees at Starbucks in India and in the United Kingdom At the time, pound was equal to 87 rupees The report says that Starbucks baristas in India are paid a mere 56 pence an hour, which is lower than the cheapest coffee that Starbucks sells in the United Kingdom A friend of yours who read the report is appalled by this information and thinks that Starbucks ought to raise its salaries substantially in India Is your friend necessarily correct? Explain your answer The following table lists 2012 GDP per capita for four countries The data are given in the national currencies of the countries It also lists the price of a Big Mac burger in local currency in each country in 2012 M06_ACEM0635_01_GE_CH06.indd 165 2012 GDP per Capita 2012 Big Mac Price Norway (krone) Poland (zloty) Turkey (Turkish lira) United Kingdom (British pound) 579,162 41,398 19,580 24,740 41 krone 9.1 zloty 6.6 Turkish lira 2.49 pounds Source for GDP: UNECE Statistical Database, compiled from national and international (CIS, EUROSTAT, IMF, OECD) official sources Source for Big Mac Prices: http://bigmacindex.org/2012-big-macindex.html The price of a Big Mac in the United States in 2012 was $4.20 Problems 165 17/03/15 1:58 PM Find more at www.downloadslide.com Using the Big Mac burger as a representative commodity common to the countries, calculate the purchasing power parity (PPP)-adjustment factor for each country, and then the PPP level of per capita GDP in each country Let us use what we have learned in the first part of the chapter to compare living standards in the United States and a hypothetical country, Argonia, in 2008 a The U.S GDP in 2008 was approximately 14 trillion dollars and the U.S population was approximately 300 million What was the per capita GDP in the United States in 2008? b Suppose that in the local currency, Argonian dollars, Argonia’s GDP in 2008 was trillion, and its population was 10 million What was Argonia’s GDP per capita in Argonian dollars? What problems you foresee in comparing this number to the U.S GDP per capita in U.S dollars computed in part a? c The Argonian dollar/U.S dollar exchange rate was equal to on January 1, 2008 (meaning that U.S dollar is worth Argonian dollars) and reached on August 1, 2008 Compute an exchange-rate-based measure of the GDP per capita in Argonia in U.S dollars on these two dates Do you think the change in Argonia’s exchange-rate-based measure of GDP per capita between these two dates reflects a true change in living standards? d McDonald’s has a thriving business in Argonia and sold a Big Mac for Argonian dollars in 2008, while at the same time, a Big Mac sold for $3.50 in the United States Using this information, provide an alternative estimate of GDP per capita in Argonia Would you trust this estimate better than the one based on exchange rates? Why or why not? Suppose you are given the following information for the country Lusitania: 2011 Population; total in Lusitania Employment Gross Domestic Product (GDP) 190 million 80 million 2,476 billion U.S dollars a What is the income per capita in Lusitania? b What is the income per worker in Lusitania? The following table gives you the same information for the country Arctica 2011 Population; total in Arctica Employment Gross Domestic Product (GDP) 80 million 40 million 3,600 billion U.S dollars c What is the income per capita in Arctica? d What is the income per worker in Arctica? 166 Chapter M06_ACEM0635_01_GE_CH06.indd 166 e Based on the given information, would Arctica be considered more productive than Lusitania? Explain your answer f How would you use the information given in both these tables to compare living standards in Lusitania and Arctica? Suppose that the GDP in current dollars for Polonia is higher than Ruritania’s GDP However, using purchasing power parity-adjusted dollars, Ruritania’s GDP is higher than Polonia’s GDP Based on this information, what would you conclude about living standards in Polonia and Ruritania? In 2011, China revised its poverty line upward to 2,300 yuan per year, or 6.3 yuan per day At the prevailing exchange rate, this was equal to a little less than a single U.S dollar Some commentators felt that China’s poverty line fell short of the World Bank’s poverty line of $1.25 per day, in 2005 purchasing power parity (PPP) U.S dollars Would you agree? What other information would you need to evaluate this claim? In this question, we will use what you learned in the second part of the chapter to compare the performance of an economy in two different time periods, as its physical capital stock and efficiency units of labor change a Suppose that from period to period 2, the unemployment rate in the economy increases Everything else remains unchanged What happens to the total efficiency units of labor? Express your results formally as an inequality, using the formula for total efficiency units of labor presented in the chapter (in particular, recall that total efficiency units of labor in two periods can be written as H1 = L1 × h1 and H2 = L2 × h2; where L is the total number of employed workers) b What are the consequences of this increase in unemployment for GDP? Express your results formally as an inequality, using the aggregate production function presented in the chapter c What are the consequences for GDP per capita and GDP per worker? d Suppose that there is a technological advance from period to period but, at the same time, a decrease in physical capital stock Can you say whether GDP will increase or decrease? Why or why not? The following table shows the change in GDP in Lithasia with changes in efficiency units of human capital GDP (in Millions of Dollars) 100 150 180 200 210 Stock of Physical Capital (Units) 15,000 15,000 15,000 15,000 15,000 Efficiency Units of Labor 16,000 20,000 24,000 28,000 32,000 | Aggregate Incomes 17/03/15 1:58 PM Find more at www.downloadslide.com a Comment on the rate of change in GDP as the economy uses more efficiency units of labor b How would the aggregate production function of this economy look if GDP is measured along the vertical axis and efficiency units of labor on the horizontal axis? c What explains the shape of this aggregate production function? Links: http://www.worldbank.org/depweb/english/beyond/ global/chapter15.html; http://data.worldbank.org/indicator/ NY.GNP.PCAP.PP.CD; http://www.worldbank.org/depweb/ english/beyond/global/chapter2.html The old Soviet Union devoted enormous resources exclusively to increasing its physical capital stock, and yet eventually the increase in the country’s GDP came to an end Based on the discussion in the chapter, explain why this was inevitable 10 The following table provides data for sources of economic growth over time This data shows that the real GDP, at constant 2005 national prices, is higher in China than India in 2010 and 2011 How the variables given below explain the real GDP differences between China and India? Index Capital stock Real GDP of human at 2005 at 2005 capital per constant constant national prices national prices person, based on years of (in Billions of (in Billions of schooling U.S dollars) U.S dollars) China India China India 11 Suppose the level of total efficiency units of labor is fixed Plot the aggregate production function with physical capital stock (K) on the horizontal axis Identify any two points as the initial amount of physical capital stock and the corresponding output An earthquake destroys a certain amount of physical capital stock Show what happens to K and the output in your graph 12 First Japan, then Korea, and now China have managed to grow very rapidly without devoting many resources to research and development (R&D) Given the importance noted in the text of technological advance as an engine of growth, this seems to be a contradiction Explain how rapid growth in these countries (and others as well) could have been achieved without a substantial R&D commitment on their part 13 The production function is given as: Y A F(K,H) A K1/33 H2/3, where H L h Country Bigg’s technology and labor force are twice the size of country Smala’s However, Smala has a greater physical capital stock, three times that of Bigg’s Which country has a higher GDP, Bigg or Smala? Given the labor force, how can Smala increase H? TFP at constant national prices (2005 1) China India China India 2010 11,504 4,180 39,662 9,408 2.6 1.9 1.2 1.1 2011 12,563 4,467 44,643 10,299 2.6 1.9 1.2 1.1 Source: Data from Penn World Table; Alan Heston, Robert Summers and Bettina Aten, Penn World Table Version 7.1, Center for International Comparisons of Production, Income and Prices at the University of Pennsylvania (Nov 2012) M06_ACEM0635_01_GE_CH06.indd 167 Problems 167 17/03/15 1:58 PM Find more at www.downloadslide.com Appendix The Mathematics of Aggregate Production Functions How did we compute, in Exhibit 6.12, what the average income per worker in India would have been if India had access to the U.S level of technology? We worked with the aggregate production function Y = A × F(K,H) using the following form, which is often estimated as an empirical approximation to data: Y = A × F(K,H) = A × K1/3 × H2/3 It is referred to as a Cobb-Douglas function and has several attractive features.4 For one, the coefficients to which K and H are raised to add up to (1⁄3 + 2⁄3 = 1) This ensures that the production function exhibits constant returns to scale: that is, increasing K and H by percent would lead to a percent increase in Y Moreover, this functional form is consistent with the empirical fact that, roughly speaking, about two-thirds of national income goes to labor and one-third to physical capital Let us now divide both sides of the above equation by the total number of workers in the economy, L, to obtain: Y * 1 = A * K1/3 * H2/3 * L L This can be rewritten as: y = Y = A * K1/3 * H2/3 * 1/3 , L L * L2/3 where y is income per worker, or GDP divided by the number of workers in the economy The last term simply rewrites 1/L differently to derive the next equation Now rearranging the previous equation, we obtain y = A * a K 1/3 H 2/3 b * a b L L Finally, recalling that H = L × h, this can be rewritten as Stated differently: y = A * a K 1/3 b * h2/3 L GDP per worker = Technology * (Capital per worker)1/3 * (Human capital per worker)2/3 This derivation also shows why there is a very tight relationship between cross-country differences in GDP per worker and cross-country differences in productivity For simplicity, assuming that each worker works the same number of hours in every country, the left-hand side of this equation is also GDP per hour worked and thus the productivity of a country The equation therefore demonstrates that productivity is determined by the three ingredients we have emphasized in the text: technology, physical capital, and human capital We next use data on GDP per worker together with data on the physical capital stock (K), or physical capital per worker, and data on human capital per worker (h) Data on GDP are available from various sources (with original information coming from national income accounts) These sources also provide information on investment, which we can use to compute physical capital stocks Finally, we can compute human capital differences across nations from differences in average years of schooling In particular, we know how much more a worker with one more year of schooling earns We can use this information to create an index, h—on the basis of differences in average years of schooling—that captures differences in human capital across nations For example, say college graduate workers 168 Appendix | The Mathematics of Aggregate Production Functions M06_ACEM0635_01_GE_CH06.indd 168 17/03/15 1:58 PM Find more at www.downloadslide.com will typically have 16 years of schooling and earn twice as much as workers with years of schooling Then if we set h = for a country with years of schooling on average, we would have h = for a country with 16 years of schooling on average Now let us start by computing the technology for the United States, denoted by AUS Using the previous equation, we arrive at: AUS = yUS KUS 1/3 a b * h2/3 US LUS As we have seen, the U.S GDP per worker is given by yUS = AUS * a KUS 1/3 b * h2/3 US LUS The expression above is obtained simply by rearranging this In the same fashion, we can find the contribution of technology to the GDP of India, which is AINDIA: yINDIA KINDIA 1/3 2/3 a b * hINDIA LINDIA We can then ask how the GDP of India would be different if instead of AINDIA we used AUS in the preceding expression We can calculate the hypothetical GDP per worker of India in the situation in which India has the same technology term, AUS, as the United States: AINDIA = yINDIA WITH US TECHNOLOGY = AUS * a KINDIA 1/3 b * h2/3 INDIA LINDIA Using our estimates of AUS, KINDIA, LINDIA, hINDIA, for example, we can compute the hypothetical GDP per worker of India, if India were able to use American technology, as $24,071 In the same way, we can plug in the U.S technology terms into the aggregate production function of any country, which enables us to the rest of the computations in Exhibit 6.12 M06_ACEM0635_01_GE_CH06.indd 169 Appendix | The Mathematics of Aggregate Production Functions 169 17/03/15 1:58 PM ... 19 50 19 59 19 60 19 69 19 70 19 79 19 80 19 89 19 90 19 99 2000–2007 (1) 8.30 11 .50 14 .96 17 .46 20.95 27.06 Physical Capital Stock per Hour Worked (2005 Constant Dollars) (2) 10 2,548 11 9,593 12 8,5 91 137,637 14 4,354... Growth 17 0 17 1 17 2 17 2 17 4 12 Contents A02_ACEM0635_ 01_ GE_FM.indd 12 17 /03 /15 7:30 PM Find more at www.downloadslide.com Patterns of Growth 17 5 Letting the Data Speak: Levels versus Growth 17 7 7.2 ... Price Index 14 0 Inflation 14 1 Adjusting Nominal Variables 14 1 Summary 14 2 Key Terms 14 3 Questions 14 3 Problems 14 3 Chapter 6: Aggregate Incomes 14 6 6 .1 Inequality Around the World 14 7 Measuring