This book explains modern macroeconomics. It does not use equations, graphs, diagrams or footnotes.
The book is designed to make modern macroeconomics available to those who never had a university course in economics or who had one years ago, now little remembered. The book is non-technical. Since readers are busy, the book is purposely confined to about a hundred pages.
It seeks to combat the lack of literacy in basic macroeconomics that is all too evident among Americans.
It covers a series of important subjects: resources; national output; living standards; economic growth; employment and unemployment; money and interest rates; inflation; government; deficits and debt; international; productivity; incentives; expectations; income distribution; asset markets; business fluctuations; creative destruction; planning horizons; international convergence; and more.
Peter M. Gutmann is professor of Economics at Baruch College of the City University of New York.
He has a doctorate from Harvard University. His dissertation title was “Income Distribution, Asset Values and Economic Growth”.
Professor Gutmann is widely known due to his pathbreaking work on the subterranean economy which created a whole industry of articles and books by economists from all over the world on that subject.
He is the author of “Macroeconomics in Brief. He has published in a range of economic journals including the American Economic Review, the Journal of Income Distribution, the Review of Economics and Statistics, and others.
Professor Gutmann teaches macroeconomics and growth economics at Baruch College of the City University of New York.
5. GROWTH OF OUTPUT
Output depends on inputs. Growth of output depends on growth of inputs. So, growth of national output depends on growth in the services of the factors of production, which in turn depends on growth in the actual factors of production.
Most investigators believe that, if all the factors of production grow at the same rate, then output will also grow at the same rate. Of course, this doesn’t occur very often in real life.
What happens when one of the factors grows, while the others do not? Under most circumstances, output will still go up, but not in proportion.. As the supply of the expanding factor grows relative to the other (static) factors, the additional output produced per additional unit of the expanding factor becomes less and less, eventually reaching zero. If still more of the expanding factor is added, output may actually decline.
This is a famous law of economics, the law of diminishing returns. It was developed in 18th century England when economists considered the addition of more and more laborers to a fixed piece of land. Today, there may be some overpopulated countries where the addition of still more labor to the fixed amount of agricultural land produces no additional output at all. However, in practice this causes migration to the cities where this additional labor usually manages to eke out a precarious living in the service sector, producing at least something, however little and inadequate.
In the industrialized countries, over the past two centuries, the stock of capital has grown faster than the labor supply. This means that each worker has worked with a greater and greater supply of capital over the years, i.e. the capital to labor ratio has increased tremendously.
Economists have reasoned that the law of diminishing returns should apply, as the ratio of the factor of production, capital, to the factor of production, labor, keeps increasing. In other words, they anticipated a lesser and lesser increase in output per increase in the capital stock to labor ratio.
Historically, this hasn’t happened. There are two main reasons. First, the stock of technology (which is difficult to measure) has also increased tremendously over the time period. Most technology is incorporated in capital equipment. When there is a net increase in the stock of capital, and even when there is just a replacement of existing capital stock which has worn out, the new capital stock necessarily incorporates additional technology. Personal computers are not replaced by the same old model; they are replaced by new models with advanced features incorporating new technology. The old model has gone out of production.
As a result, historically, it has not been true that the ratio of the same old capital stock to labor increased, triggering the law of diminishing returns. Actually, what has increased is the ratio of capital stock-cum-technology relative to the labor supply. Another way of looking at this is to say that the simultaneous increase in the stock of technology counterbalanced the law of diminishing returns as applied to the ratio of the factor of production, capital, to labor.
The second reason why the law of diminishing returns did not operate, historically, is the growth in the stock of education, which is incorporated in the labor force. A worker today is very different from a worker fifty or a hundred years ago. He is far better educated, far better able to work with advanced technology. So, the tremendous increase in the stock of education, simultaneous with increase in the stock of capital, also offsets application of the law of diminishing returns to the increase in the capital to labor ratio.
The net result of all this appears to be that the ratio of capital stock to output, far from declining, has remained more or less constant in most industrialized countries, over extended periods of time. To be sure, there are fluctuations, but the average does not appear to have changed a lot. This is to say that the growth in the stock of technology and the growth in the stock of education have offset the law of diminishing returns applicable to the increase in the stock of capital relative to the size of the labor force. Net result: the capital/output ratio has remained more or less constant. (Some investigators believe that the capital/output ratio has actually declined in the past two centuries.)
Economists subsume all this into so-called production functions that relate the inputs of the factors of production to output of GDP in mathematical terms. The most popular of these is the Cobb-Douglas production function.
When the growth rate of the factors of production declines, then the growth rate of output also declines. In the US, for example, the decline in the growth rate of the capital stock from the mid-seventies to the mid-nineties is often cited as one of the causal elements of decline in the growth rate of national output during this period (though there are other reasons). However, it should be realized that the decline in the growth rate of the capital stock also implies at least some decline in the growth rate of the stock of technology, since most technology is incorporated in capital stock.