No Such Thing as a Free Lunch: Principles of Economics (Part 103)

"Don't go through life, grow through life." 

Eric Butterworth

Long-Run and Short-Run Concerns: Growth, Productivity, Unemployment, and Inflation

(Part A)

by

Charles Lamson

An ideal economy is one in which there is rapid growth of output per worker, low unemployment, and low inflation. In this situation government economic policy makers can sleep well at night. Alas, however, an economy is not always in this ideal state. There can be times of low growth, high unemployment, and high inflation. A key part of macroeconomics is to consider what determines output, unemployment, and inflation. Why is the growth of output per worker sometimes high and sometimes low? Why are unemployment and inflation sometimes high? We begin in upcoming posts the task of explaining how the macroeconomy works. Before jumping into the analysis, however, in the next several posts it will be useful to spend a little more time on description.

We first discuss long-run issues, namely, the rate of growth of output and output per worker over a long period of time. We then move to the short-run issues of unemployment and inflation.

Long-Run Output and Productivity Growth

Before we begin our discussion of economic growth it is important to review what is meant by "capital." Capital is anything that is produced that is then used as an input to produce other goods and services. Capital can be tangible, such as buildings and equipment, or intangible. The knowledge and skills acquired through education and training can be thought of as intangible "human capital." Capital can be private or public. The roads and bridges that we drive and walk on are a part of the public capital stock. Capital, thus, can take many forms. To simplify the discussion, however, we will sometimes refer to capital as simply "machines."

In a simplified economy, machines (capital) and workers (labor) are needed to produce output. Suppose that an economy consists of 6 machines and 60 workers, with 10 workers working on each machine, and also that the length of the work week is 40 hours, with this workweek resulting in 50 units of output per month per machine. Total output (GDP) for the month is 300 units (6 machines * 50 units per machine) in this simple economy.

How can output increase in this economy? There are a number of ways. One way is to add more workers. If, for example, 12 workers are added, two extra per machine, then more output can be produced per machine per hour worked because there are more workers helping out on each machine. Another way is to add more machines. For example, if 4 machines are added, then the 60 workers have a total of 10 machines to work with instead of 6, and more output can be produced per worker per hour worked. A third way is to increase the length of the workweek (e.g., from 40 hours to 45 hours). With workers and machines working more hours, more output can be produced. Output can thus increase if labor or capital increases or if the amount of time labor and capital are working per week increases.

Another way for output to increase in our economy is for the quality of the workers to increase. If, for example, the education of the workers increases, this may add to their skills and thus increase their ability to work on the machines. Output per machine might then rise from 50 units per month to some larger number per month. Also, if workers become more physically fit by exercising more and eating less fat and more whole grains and fresh fruits and vegetables, this may increase their output on the machines. People are sometimes said to be adding to their human capital when they increase their mental and physical skills.

The quality of the machines may also increase. In particular, new machines that replace old machines may allow more output to be produced per hour with the same number of workers. In our example, it may be that 55 instead of 50 units of output can be produced per month per new machine with 10 workers per machine and a 40-hour work week. An obvious example is the replacement of an old computer with a new, faster one, which allows more to be done per minute of work on the computer.

To summarize, output can increase if there are more workers, more skills per worker, more machines, faster machines, or longer workweek.

*CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 411-413*

end