What two kinds of changes in the capital stock can improve labor productivity? How can each type be illustrated with a per-worker production function? What determines the slope of the per-worker production function? 14-) (Rules of the Game) How do “rules of the game” affect productivity and growth? What types of “rules” should a government set to encourage growth?
Two kinds of changes in the capital stock that can improve labor productivity are physical capital accumulation and technological progress.
1. Physical capital accumulation: Increasing the amount of physical capital (e.g., machinery, equipment, infrastructure) available per worker can enhance labor productivity. This can be illustrated with a per-worker production function, which shows the relationship between the amount of physical capital per worker and the level of output per worker. As the amount of physical capital per worker increases, the per-worker production function will shift upward, indicating higher levels of output per worker.
2. Technological progress: Advancements in technology can also lead to improved labor productivity. This can be depicted with a per-worker production function where the level of output per worker increases due to the adoption of new technologies or improvements in existing technologies. Similarly, the per-worker production function will shift upward, reflecting the increased productivity resulting from technological progress.
The slope of the per-worker production function is determined by the diminishing marginal returns to capital. Initially, as the amount of physical capital per worker increases, there will be a significant positive impact on labor productivity, leading to a steep slope of the per-worker production function. However, as the capital stock continues to increase, the additional gains in productivity become smaller, resulting in a flatter slope. This diminishing marginal productivity of capital reflects the idea that as more capital is added, the incremental increase in output becomes smaller.
The "rules of the game" refer to the institutional framework, policies, and regulations that govern economic activity. These rules have a significant impact on productivity and growth.
1. Productivity: Well-designed rules of the game can promote productivity by providing a stable and predictable environment for businesses to operate. Clear property rights, enforceable contracts, and a reliable legal system are essential in fostering a productive business environment. When these rules are in place, businesses are more likely to invest in capital, engage in research and development, and innovate, leading to higher productivity levels.
2. Growth: The rules of the game can also influence economic growth by creating incentives or barriers for investment, entrepreneurship, and competition. Governments should set rules that encourage investment in physical and human capital, promote market competition, and facilitate access to credit and markets. Additionally, an effective regulatory framework that balances consumer protection and business-friendly policies can foster sustainable and inclusive growth.
In summary, the rules of the game significantly impact productivity and growth. An enabling environment with clear rules, protection of property rights, enforceable contracts, and supportive policies can encourage investments, promote competition, and foster innovation, leading to higher productivity levels and sustainable economic growth.