Productivity: Chap. 4, The Theory of Aggregate Supply
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nitin1232Productivity: Chap. 4, The Theory of Aggregate Supply
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nitin1232Productivity
Chap. 4, The Theory of
Aggregate Supply
Income depends on Output,
Output depends on productivity and
labor
GDP, Y, is value produced.
GDP can be decomposed:
Yt Yt Lt
POPt Lt POPt
L = Labor is defined as hours worked.
Main concern in this chapter is productivity
Income per person, 2003
Groningen Growth & Development Center [Link]
GDP per Person
160.00
140.00
120.00
100.00
HK = 100
80.00
60.00
40.00
20.00
0.00
Hong Kong Singapore South Taiwan Japan USA France
Korea
Productivity
GDP per Hour Worked
200.00
180.00
160.00
140.00
120.00
HK = 100
100.00
80.00
60.00
40.00
20.00
0.00
Hong Kong Singapore South Taiwan Japan USA France
Korea
Employment
Hours Worked per Capita
120.00
100.00
80.00
HK = 100
60.00
40.00
20.00
0.00
Hong Kong Singapore South Taiwan Japan USA France
Korea
Production Factors of Production
Capital
Output Technology Labor
etc.
Factors of Production: Capital
Capital (Kt) is the stock of durable goods
(machines, equipment, buildings, etc.)
used to produce other goods.
Unit of measure is dollar-value.
Difficult to measure directly, so it is defined
indirectly.
Stock vs. Flow
Stock: Some variable that accumulates. Flow:
Channel of increase or decrease of a stock.
Example
Stock: Government Debt
Flow: Government Revenue, Government
Expenditure
Example
Capital
Flow: Investment (It), Depreciation (Dpnt)
Stocks and Flows
Figure 2.6
©2002 South-Western College Publishing
Capital is Defined Recursivel
Perpetual Inventory Method
K t 1 K t I t Dpnt
Method requires some initial guess at
capital stock. As original guess capital
depreciates, measure becomes more
accurate.
Constant Depreciation Rate
K t 1 K t I t dK t (1 d ) K t I t
Hong Kong Investment to Capital
Ratio
Investment to Capital Ratio (d = .09)
0.25
0.2
0.15
0.1
0.05
0
86
94
96
80
82
84
88
90
92
98
00
#
02
19
19
19
19
19
19
19
19
19
19
20
20
Hong Kong capital stock
Capital
3500000
3000000
2500000
2000000
1500000
1000000
500000
0
80
84
86
88
90
92
94
96
98
00
82
#
02
19
19
19
19
19
19
19
19
19
19
20
20
Productivity: Two Concepts
There are two basic measures of productivity.
1. Average Productivity: The average productivity of a
factor is output divided by amount of factor used.
Y Y
,
L K
2. Marginal Productivity: The extra output that would
be produced if an extra unit of a factor were used.
Y Y
,
L K
Capital Productivity
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Hong Kong EU USA
Aggregate Production Function
Assume aggregate output can be written
as an algebraic function of the aggregate
factors. Yt Ft ( K t , Lt )
Technological change over time is
represented as a scaling factor, Qt.
Yt F (Qt , K t , Lt )
Example: Cobb-Douglas
Yt K t (Qt Lt )1 a
a
Marginal Productivity of Labor
Holding capital constant, the effect on GDP of
increasing labor by a small amount. Y = F(L)
MPL = ΔY/ΔL
The slope of the production function
For very small increases in labor, can be calculated
with first derivative of output with respect to labor.
MPL = F’(L)
Diminishing returns suggests that if you hold one
factor constant, marginal returns are a
diminishing function.
Production Function
(fixed K)
ΔY
ΔL
ΔY
ΔL
L
Marginal Productivity Function
(fixed K)
MPL
MPL
L
Marginal Productivity Function
(fixed L)
MPK
MPK
K
Advantages of Cobb-Douglas Production Function
Constant Returns to Scale
If you increase both capital and labor by a
factor of N, then you will also increase output
by a factor of N
Yt Kt (Qt Lt )1 a N Yt N K t (Qt N Lt )1 a
a a
Implications for Country Size: Output per
capita depends only on capital per capita and
labor per capita, not on population size itself.
a
Yt Kt Lt 1 a
(Qt )
POPt POPt POPt
Productivity Function
Labor productivity is a function of
technology and the capital-labor ratio.
Yt K t (Qt Lt ) Kt
a 1 a a 1 a
(Qt Lt )
yt
Lt Lt Lat L1t a
Kt
a a
(Qt Lt ) 1 a
Kt 1 a
Qt kta Qt1a
Lat L1t a Lt
Advantages of Cobb-Douglas Production Function
Average Product & Marginal
Product
Under Cobb-Douglas, the marginal product is
proportional to average product.
1 a a Y
MPL (1 a) K Q L (1 a )
a
L
a 1 1 a Y
MPK a K (QL) a
K
All intuition about things that change average
productivity carry-over 1-to-1 to marginal
productivity.
Advantages of Cobb-Douglas Production Function
Log-linear
Take natural log of output
Yt K t (Qt Lt )1 a ln Yt ln K t a ln Qt1 a ln Lt1 a
a
ln Yt a ln K t (1 a ) ln Qt (1 a) ln Lt
Growth rate of output is a linear function of
the growth rate of capital, labor, and
technology.
ln Yt a ln K t (1 a ) ln Qt (1 a ) ln Lt
ln Yt 1 a ln K t 1 (1 a) ln Qt 1 (1 a) ln Lt 1
gtY ag tK (1 a) g tQ (1 a) g tL
Marginal Product = A firm can raise its
profits by increasing
Marginal Cost labor as long as the
Profit maximization cost of the extra labor
suggests that the is less than the extra
marginal product of a goods produced. Since
factor should equal its the extra goods
real cost. produced drops as
The real cost of labor is more labor is added,
the real wage, the dollar firms will hire more
wage rate divided by the labor until the marginal
price level. product falls as low as
Wt the real wage.
MPL
Pt
Labor Demand Schedule
(fixed K)
W/P
MPL
L
Advantages of Cobb-Douglas Production Function
Factor Shares
Labor compensation is the product of the
wage rate and the quantity of labor WtLt.
Wt Yt
(1 a) Wt Lt (1 a) PY
t t
Pt Lt
Income left over to owners of capital is
also a constant share of output a∙Yt
Implications
Labor share of income (labor intensity) is
equal to the ratio of the marginal product
of labor to the average product.
Wt
Y Y
Wt Lt Pt MPLt L Y 1 a
PY Yt APLt Y L
t t
Lt L L
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0
Mar-72
Mar-74
Mar-76
Mar-78
Mar-80
Mar-82
Mar-84
Mar-86
Mar-88
Mar-90
Labor Share of Income
Mar-92
Mar-94
Mar-96
Labor Intensity ≡1- a ≈2/3
Mar-98
USA
JAPAN
Total Factor Productivity
Total factor productivity measures the total
effectiveness of an economy in applying
all of its factors of production.
TFP is a geometrically weighted average
of capital and labor productivity with factor
WL
intensity, at and 1-at = PY used as weights.
[1 at ] at
Yt Yt Wt Lt
TFPt [1 at ]
Lt Kt PY
t t
TFP Growth at [1 at ]
Yt Yt Yt Y
TFPt ln TFPt at ln (1 at ) ln t
TFP is log Lt Kt Lt Kt
linear ln TFPt at ln Yt ln Lt (1 at ) ln Yt (1 at ) ln Kt
ln TFPt ln Yt ln Lt (1 at ) ln K t
TFP growth rate is the gap between GDP growth
rate and the weighted average of the growth
rate of the factors of production.
ln TFPt ln TFPt 1 ln Yt ln Yt 1 (1 at )[ln Lt ln Lt 1 ] at [ln K t ln K t 1 ]
tTFP tY at tL (1 at ) tK
TFP Growth Rates over time
1.4%
1.2%
1.0%
0.8% 1980-1995
0.6% 1995-2001
0.4%
0.2%
0.0%
USA EU
Advantages of Cobb-Douglas Production Function
TFP equals technology
If production is according to Cobb-
Douglas, then TFP directly measures
technology. at =a.
K t a Qt Lt
1 a [a] 1 a
Yt Yt Yt
TFPt 1 a a Qt1 a
Lt Kt Lt K t Lt1 a K t a
Growth Accounting
When we measure growth, we might want
to determine if this is caused by capital
growth, labor growth or capital growth.
Growth caused by
gY Capital a×gK
Labor (1-a)×gL
Technology gTFP
The East Asian Miracle 1965-2001
Output Growth Rate
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
Hong Kong Singapore South Korea Taiwan USA
Myth of the East Asian Miracle
Alwyn Young, QJE 2001
TFP Growth Rates
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Hong Kong Singapore South Korea Taiwan USA EU
Criticisms
Critics of Young’s work that because of data
mismeasurement, they assumed that East Asian
production functions were different (greater
capital intensity) than developed economies.
Even using same production functions, most
East Asian growth differentials are due to factor
accumulation not TFP growth.
One key point, capital productivity was declining
in East Asia over this time period.
Growth Accounting: 1965-2000
12.0%
10.0%
8.0%
TFP
6.0% Labor
Capital
4.0%
2.0%
0.0%
Hong Kong Singapore South Korea Taiwan USA
Capital Productivity
Capital Productivity
0
Hong Kong Singapore South Korea Taiwan USA
-0.005
-0.01
-0.015
-0.02
-0.025
-0.03