Back To CourseEconomics 102: Macroeconomics
16 chapters | 137 lessons | 14 flashcard sets
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Jon has taught Economics and Finance and has an MBA in Finance
We're talking about productivity, which is an economy's long-run growth engine. Before we begin, I want you to imagine the engine of an automobile. Just imagine a car is driving on the expressway going 55 miles per hour through the town of Ceelo. If you could see under the hood of that car while it's in motion, you could see that the engine is in there. Imagine you're looking at the inside of the engine. This is a four-cylinder car, which means that inside the engine there are four cylinders going up and down, and this is what makes the car go. If you think of an economy as a car, then productivity is its long-run growth engine. We'll come back to this later, but now I want you to go with me on a little trip.
Suppose that Tom, an economist, is on a three-hour tour in a boat on the ocean. Everything is going great until he gets caught in a terrible storm and becomes stranded on a desert island. After about six hours of wandering around the island, Tom finds a volleyball that washed up from the ocean and, feeling somewhat lonely, decides to name it Wilson and talk to it throughout the day. Thankfully, a brand new portable gas grill washes up next to the volleyball. How cool is that! Tom is a great example of a one-man economy, because everything that Tom wants to consume, he must also produce. That means his income is totally equal to his production. Let's also say that Tom loves to eat salmon, and it just so happens that there are salmon in the ocean off the coast of this desert island. That means that his standard of living, which is his economic well-being, is totally determined by how productive he is.
Productivity is the amount of output that gets produced per unit of input. Tom's productivity will be measured in terms of how many salmon he can catch with a given amount of effort. Labor productivity is the rate of a worker's output per unit of input in a certain amount of time. Tom's labor productivity will be measured in terms of how many salmon he can catch in an hour. If he catches only a few salmon, his labor productivity is low. If he catches a lot of salmon, then his productivity level is high. What we want to know in this lesson is: What determines Tom's productivity? If we can increase his productivity, then we can make his economy grow for a long time, because productivity is an economy's long-run growth engine.
The first thing we want to keep in mind is that Tom is a sole proprietorship, a one-man band, a one-person economy, meaning that he's the grunt worker, the HR department and the CEO, all rolled into one. In fact, when Tom needs approval to change the location of Wilson, his volleyball, he is concerned that the neighbors (that's Tom) will complain to the city council (also Tom) about having too much traffic. In order to avoid any issues with the town judge (you guessed it, Tom), he calls the mob for help (if you said Tom, you'd be correct). In all seriousness, Tom's productivity, or output per unit of input, is affected by four primary factors. Let's take a look at each one.
The first thing that affects Tom's productivity is how many fishing poles he has. Let's say that Tom is able to create one fishing pole. Assuming he can catch one fish per hour, then after an eight-hour workday in the beautiful sunshine with a clear blue ocean and no cubicles in sight, Tom is able to produce 8 x 1 = 8 fish. This is enough for him to make salmon sandwiches, smoked salmon (I love smoked salmon by the way), salmon croquettes, grilled salmon, poached salmon and salmon étoufée. Okay, let's get back to the fishing poles. The more fishing poles that Tom has, the more salmon he can catch. If he has two poles, he can catch 16 salmon per day instead of eight. The fishing poles in the illustration are tools that Tom uses to be productive. Economists call this physical capital. Physical capital is the equipment and structures used to produce goods and services. Workers are more productive when they have more tools to help them produce.
The next thing that affects Tom's productivity is how much understanding and ideas he has access to about the science of fishing and what the best methods are for catching salmon. If Tom has no access to this knowledge, he catches nothing and eats dirt and talks to his volleyball way too much. Thankfully, while looking under a rock, Tom finds a brand new encyclopedia of advanced fishing techniques (hey, how did that get there?). Anyway, economists call this technology. Technology is a nation's understanding of how the world works. Tom has the encyclopedia, so he has the technology. However, this doesn't mean that he's read the encyclopedia. We'll talk about that in a minute. But having the encyclopedia is the first step to being able to use what's in it.
Another factor that affects Tom's productivity is how good he is at fishing for salmon. Let's say that Tom is just okay at catching fish and he catches one fish per hour, which is what he started with in the last example. Now imagine that Tom is really good at catching salmon, and he's able to catch three fish per hour. This would enable him to catch 3 x 8 = 24 fish per day instead of eight. Wow, that's a lot of salmon étoufée. Economists call this human capital (no, not the salmon étoufée; I'm talking about Tom's ability to catch fish). Human capital is the knowledge and skills that workers acquire through education, training and their experience. The more human capital Tom gets, the better at fishing he becomes. Let's assume that before Tom's unfortunate happenstance, he invested his time in the Study.com website and increased his human capital by 500%. He also read through part of the encyclopedia that he found on the island. Now he can catch five salmon per hour, work only four hours per day and spend the rest of his day reading a new book that he just found in the grass titled The 4-Hour Workday.
Finally, the last factor that affects Tom's productivity is how many salmon are actually in the water for him to catch. (Some people would call that a school; we call it an Study.com.) That means that Tom's productivity will be much higher, because it won't take as long to catch the salmon. Economists call these natural resources. Natural resources are the inputs to production that come from nature.
These are the four factors that not only determine Tom's productivity, but also make a nation more productive. Now think of an economy as a car with a four-cylinder engine inside of it. That four-cylinder engine is productivity, and the four things we talked about that affect Tom's productivity are the main determinants of the productivity of a nation. When all four cylinders are working well, the car can go fast for a long time. When a nation decides to invest in any one of these things, it will increase productivity, and this will lead to increases in its standard of living.
Paul Krugman, in his book The Age of Diminishing Returns, said this: 'Productivity isn't everything, but in the long run, it is almost everything. A country's ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker,' which we call productivity. That's why productivity is important. These determinants of productivity also help explain why some nations have grown at faster rates than other nations. Nations with higher levels of productivity tend to grow faster than nations with lower levels.
Let's do a quick review of the most important points. A nation's standard of living is determined by its productivity, defined as output per worker. Labor productivity is simply output per worker in a given amount of time, such as an hour. Here are the four most important determinants of the productivity of a nation:
When a nation invests in physical capital, it can produce more goods and services. When it invests in research and development, it develops technology that makes workers more productive. When a nation invests in human capital, which is education and training, its workers tend to become more productive. Finally, when a nation invests in natural resources, it can develop them in productive ways. When a nation invests in these four things, it will not only increase productivity but will raise its standard of living. These four determinants of productivity help explain why some nations have grown faster than other nations.
By the time you finish this lesson you'll be able to:
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Back To CourseEconomics 102: Macroeconomics
16 chapters | 137 lessons | 14 flashcard sets