Clear English summary of chapter 3 of the book Burda & Wyplosz. Conveniently divided by section and key terms are in bold. Part of the examination of, among other things the first year of Economics and Business, Fiscal Economics and Mr.drs. program. FEB11002 Macroeconomics.
Chapter 3: The Fundamentals of Economic Growth
2. Thinking about Economic Growth: Facts and Stylized Facts
Production function = the production function relates the output of an economy –its GDP-
to productive inputs. Most important ones: physical capital stock (K) and labour (L). Y=F(K,L)
The ratio ∆Y/∆K, the amount of new output per unit of incremental capital, is called the
economy’s marginal productivity.
Diminishing marginal productivity = holding labour L unchanged, adding to the capital stock
K allows an economy to produce more, but in smaller and smaller increments.
Constant returns to scale: when capital and labour were both doubled, and the production
function also doubled.
Increasing returns to scale: if a doubling of inputs leads to more than a doubling of output.
Decreasing returns to scale: when output increases by less than 100%.
A property of constant returns production function emerges: output per hour of work – the
output-labour ratio (Y/L) - depends only on capital per hour of work - the capital-labour
ratio (K/L). Production function: y = f(k)
The output-labour ratio Y/L is also called the average productivity of labour: it says how
much, on average, is being produced with one unit of work. The capital-labour ratio K/L
measures the capital intensity of production.
Because of diminishing marginal productivity, the curve (y=f(k)) becomes flatter as the
capital-labour ratio increases.
Economist Nicolas Kaldor studied economic growth in many countries over long periods of
time and isolated several stylized facts about economic growth.
Stylized facts = empirical regularities found in the data.
Kaldor’s stylized facts:
Stylized Fact No. 1: both output per capita and capital intensity keep increasing
It seems that GDP to grow without bound. Yet labour input, measured in person-hours of
work (L), grows much more slowly than both capital (K) and output (Y). Put differently, both
average productivity (Y/L) and capital intensity (K/L) keep rising. Because income per capita
(Y/N) is closely related to average productivity or output per hour of work (Y/L), economic
growth implies a continuing increase in material standards living.
Stylized Fact No. 2: the capital-output ratio exhibits little or no trend over time
As they grow in a seemingly unbounded fashion, the capital stock and output tend to track
each other. As a consequence, the ratio of capital to output (K/Y) shows little or no
systematic trend.
Stylized Fact No. 3: hourly wages keep rising
The long-run increases in the ratios of output and capital to labour (Y/L and K/L) mean that,
over time, an hour of work produces ever more output. Simply; workers become more
productive. Their wages per hour should also rise. Growth rises living standards for workers.
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