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2. Labor. Labor can contribute to economic growth in two ways;
a. An increase in the quantity of labor will increase Real GDP. A larger labor force can
produce more than a smaller labor force. But if an increase in the quantity of labor is not
accompanied by an increase in capital and/or an improvement in technology, labor
productivity will tend to decrease (due to the law of diminishing marginal returns, see
Example 7). If labor productivity decreases, per capita Real GDP will tend to decrease.
Example 2: If the population on Gilligan’s Island doubles, but there is no increase in capital and
no improvement in technology, labor productivity will likely decrease and so will the standard of
living.
b. An increase in labor productivity (output per unit of labor) will increase both Real GDP
and per capita Real GDP. Labor productivity can be increased by;
(1) An increase in human capital. Human capital is developed ability that increases a
person’s productivity. Human capital is developed primarily through education and
training and through work experience. To increase human capital requires saving and
investing, just as increasing physical capital requires saving and investing.
Example 3: According to the College Board, the average cost of tuition, fees, room, and board at
four-year public colleges was $18,943 for 2014/2015. For four-year private colleges, the average
cost was $42,419.
(2) An increase in physical capital. Physical capital is increased by investment in physical
capital (see point 3. below). If each worker has more physical capital to work with, labor
productivity will increase.
Example 4: India is the largest milk producer in the world. The U.S. is second. India has over ten
times as many dairy cows (including buffaloes) as the U.S., but produces only about 35 percent
more milk. The vast majority of milk production in India is by farmers with one or two cows. In the
U.S., the average dairy farm has about 140 cows. U.S. dairy farmers have far more capital
equipment than Indian dairy farmers. Labor productivity on U.S. dairy farms is about 100 times
greater than labor productivity on Indian dairy farms.
For a more detailed discussion of the importance of labor productivity, see the appendix at
the end of Chapter 15 on “The Power of Productivity”.
3. Capital. Increases in capital lead to increases in labor productivity and in per capita Real
GDP. Increases in capital are made possible by saving (delaying consumption). Resources
must be used to produce capital goods instead of consumer goods. Thus, increases in capital
require a sacrifice in the form of a lower current standard of living. Nations with higher savings
rates (and thus higher investment rates) tend to achieve more rapid economic growth,
particularly when investment decisions are determined in competitive markets.
4. Technology. Technological advance is the ability to produce more output per resource.
Technological advance can result from;
a. Improved capital. A typist using a word processor will be much more productive than the
same typist using a manual typewriter.
b. Increased human capital. As the work force becomes better educated and trained and
gains more work experience, labor productivity improves. When Gilligan first becomes
stranded on his island, he won’t be very proficient at catching fish. With experience, his
fish-catching productivity should increase.
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c. Improved production techniques. As improvements are made in both physical and
human capital, better production techniques can be developed and implemented.
14 - 3 Economic Growth