Natural resources. Macroeconomics The Production Function. Natural resources. Spreadsheet basics. What s happening? What s happening?

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1 Natural resources Good or bad for economic performance? Macroeconomics The Production Function Examples? Why? 2 Natural resources What we know Countries with lots of resources do worse on average Dutch disease, resource curse Abundant resources: Nigeria, Liberia, Middle East, Venezuela Scarce resources: Japan, Switzerland Suggestions why Primary: corruption Secondary: government programs, exchange rate Spreadsheet basics Formula Copying Mean, standard deviation, and correlation 3 4 What s happening? GDP number came out Friday for 2015Q4 (Oct-Dec) What happened? What s happening? 5 6 1

2 GDP release GDP release Ben Casselman, 538 blog The Bureau of Economic Analysis will release its preliminary estimate of economic growth in the final three months of The report will likely show that gross domestic product grew very slowly at the end of the year. My advice: Ignore this number. Preliminary GDP estimates are little more than rough estimates. What do you take from this? Justin Fox, Bloomberg US real gross domestic product grew at a 0.7 percent annualized pace in the fourth quarter of 2015, the government announced today. Forget that number. It is the advance estimate, and the Bureau of Economic Analysis will revise it again and again over the coming months and years. What do you take from this? 7 8 About the course It s about countries Which ones are doing the best? Reminders Which ones have attractive business opportunities? 9 10 About slides Reminder: real and nominal GDP Catalyst for class discussion Not intended to be read on their own More than we need: don t panic if we skip some Subject to change without notice Real GDP ( quantity ) GDP at 2010 prices GDP in 2005 USD GDP in USD, PPP adjusted GDP chain-weighted in 2010 USD Nominal GDP ( value = price times quantity ) GDP at current prices GDP in LCUs Both come from NIPA : National Income and Product Accounts

3 Reminder: GDP per capita (USD, PPP adj) Roadmap Practice Problems #0, what s happening, reminders Economic history of the world Theory: the production function Inputs: capital and labor Productivity US France Japan China India Brazil Mexico Source: World Bank, World Development Indicators Economic history of the world Until recently, life was poor, nasty, brutish, and short Thomas Hobbes, Leviathan, 1651 Economic history of the world [In the natural state of Man] there is no place for industry. [There is] continual fear and danger of violent death, and the life of man [is] solitary, poor, nasty, brutish, and short Economic history of the world GDP per capita (1990 international USD) Statistic Population (millions) GDP Per Capita (1990 USD) Life expectancy (years) Year ,042 6, , Region Year Western Europe ,218 21,672 Western offshoots ,202 30,152 Japan ,816 Latin America ,973 Former USSR ,904 China ,725 Africa ,760 World Average ,614 Source: Angus Maddison, Millenial Perspective. 17 Source: Angus Maddison, website. 18 3

4 Some examples Growth gdp per capita (1990 USD, log base 2) 15 United States Germany 11 Argentina 10 Ghana 9 China Annualized Growth ( , %) 10 China 8 6 India 4 US Per Capita Income (1980) 19 Source: World Bank, World Development Indicators. 20 Summary Several centuries ago, we were all poor and died young Now there s enormous variation across countries Also variation in growth rates Modest variation among rich countries Greater variation among poor countries Questions Why? What will the future bring? Where are the opportunities? Open questions Why did Western Europe do so well? Why not the Greeks and Romans? Why not China? Why not India? Why not the Islamic world? A controlled experiment Theory: The Production Function

5 Why theory? What kind of theory? A tool to help us organize our thoughts Simplify a complex world Use math for precision Use it to interpret data Albert Einstein Make things as simple as possible but not simpler. Georgia O Keefe Me Nothing is less real than realism. Details are confusing. It is only by selection, by elimination, by emphasis that we get to the real meaning of things. Let s keep things simple Theory: the picture Theory: the math Capital & Labor Political Process GDP Productivity Institutions The idea: relate output to inputs Mathematical version ( production function ): Y = A F(K,L) = A K α L 1-α A formula we can compute in a spreadsheet Definitions: K = quantity of physical capital used in production (plant and equipment) L = quantity of labor used in production A = total factor productivity (everything else) α = a parameter we set equal to 1/3 (more soon) Production function properties Production function properties More inputs lead to more output Positive marginal products of capital and labor Diminishing marginal products If we increase one input at a time, each increase leads to less additional output Marginal product = partial derivative of production function Constant returns to scale If we double **both**inputs, we double output (no inherent advantage or disadvantage to size) output A = 1 L = 100 a = 1/ capital stock

6 What is α? Properties of the Cobb-Douglas function Share of income paid to capital = α Share of income paid to labor = 1 α These share are constant, regardless of output level Income shares are (roughly) constant in data Share of income to capital = α = 1/3 GDP by income type share of total GDP labor compensation prop. income rental income 0.2 corp. profits 0.1 interest GDP by income type Where does αcome from? share of total GDP payments to labor payments to capital labor share 2/3 capital share 1/ Capital s share of value-added If you know calculus, this is how we show it Profit is Profit = py rk wl = pak α L 1-α rk wl Maximize profit by setting derivative wrtk equal to zero Multiply by K dprofit/dk = αpak α-1 L 1-α r = 0 α pak α L 1-α = rk Evidence (last week): about 1/3 α = rk / pak α L 1-α 34 Capital (K) Measuring capital What we mean: plant and equipment, physical capital Why does it change? Depreciation/destruction New investment ( capex ) Mathematical version: Adjustments for quality? K t+1 = K t δ t K t + I t = (1 δ t ) K t + I t Option #1: direct surveys of plant and equipment Option #2: perpetual inventory method Pick an initial value K 0 Pick a depreciation rate (or measure depreciation directly) Measure K like this: K t+1 = (1 δ t )K t + I t In practice, #2 is the norm with #1 as benchmark: Get I from NIPA [ real investment] Set δ= 0.06 [ballpark number] Example: K 2010 = 100, δ= 0.06, I = 13 K 2011 =??

7 Labor (L) Measuring labor What we mean: units of work effort Why does it change? Population growth Fraction of population employed (extensive margin) Hours worked per worker (intensive margin) Our starting point: number of people working Our starting point L = number of people working Adjustments for hours worked Replace L with hl (h = hours per worker) Adjustments for skill, education Replace L with HL (H = human capital ) H commonly connected to years of school Business Week, Nov 2012: Last year, for the first time, sales of adult diapers in Japan exceeded those for babies. Target markets in Japan? US?

8 Productivity (A) Standard number Average product of labor: Y/L How do we measure it? Measure output and labor input, take the ratio Our number Total Factor Productivity (TFP): A = Y/F(K,L) How do we measure it? Same idea, but input combines capital and labor ( total )

9 Productivity Production function review Solve the production function for A Y = A K α L 1-α A = Y/[K α L 1-α ] = (Y/L)/(K/L) α Example: Y/L = 33, K/L = 65, A = 33/65 1/3 = 8.21 Note: units meaningless, but the same across time or countries Remember: Y = A F(K,L) What changes in this equationif A firm builds a new factory? Fewer people retire at 65 Spanish banks channel funds to unproductive firms Workers shift from agriculture to industry in Viet Nam? Competition drives inefficient firms out of business? Venture capital fund identifies good unfunded projects? Alaska builds a bridge to nowhere? China invests in massive infrastructure projects? Takeaways Production function links output to inputs and productivity: Capital input (K) Y = A K α L 1-α Plant and equipment, a consequence of investment (I) Labor input (L) Population growth, age distribution, participation, hours (h), skill (H) TFP (A) can be inferred from data on output and inputs Everything else 51 9