Chapter 3: The Fundamentals of Economic Growth
2. Thinking about Economic Growth: Facts and Stylized Facts
Production function = the production function relates the output of an economy –its GDP-
to productive inputs. Most important ones: physical capital stock (K) and labour (L). Y=F(K,L)
The ratio ∆Y/∆K, the amount of new output per unit of incremental capital, is called the
economy’s marginal productivity.
Diminishing marginal productivity = holding labour L unchanged, adding to the capital stock
K allows an economy to produce more, but in smaller and smaller increments.
Constant returns to scale: when capital and labour were both doubled, and the production
function also doubled.
Increasing returns to scale: if a doubling of inputs leads to more than a doubling of output.
Decreasing returns to scale: when output increases by less than 100%.
A property of constant returns production function emerges: output per hour of work – the
output-labour ratio (Y/L) - depends only on capital per hour of work - the capital-labour
ratio (K/L). Production function: y = f(k)
The output-labour ratio Y/L is also called the average productivity of labour: it says how
much, on average, is being produced with one unit of work. The capital-labour ratio K/L
measures the capital intensity of production.
Because of diminishing marginal productivity, the curve (y=f(k)) becomes flatter as the
capital-labour ratio increases.
Economist Nicolas Kaldor studied economic growth in many countries over long periods of
time and isolated several stylized facts about economic growth.
Stylized facts = empirical regularities found in the data.
Kaldor’s stylized facts:
Stylized Fact No. 1: both output per capita and capital intensity keep increasing
It seems that GDP to grow without bound. Yet labour input, measured in person-hours of
work (L), grows much more slowly than both capital (K) and output (Y). Put differently, both
average productivity (Y/L) and capital intensity (K/L) keep rising. Because income per capita
(Y/N) is closely related to average productivity or output per hour of work (Y/L), economic
growth implies a continuing increase in material standards living.
Stylized Fact No. 2: the capital-output ratio exhibits little or no trend over time
As they grow in a seemingly unbounded fashion, the capital stock and output tend to track
each other. As a consequence, the ratio of capital to output (K/Y) shows little or no
systematic trend.
Stylized Fact No. 3: hourly wages keep rising
The long-run increases in the ratios of output and capital to labour (Y/L and K/L) mean that,
over time, an hour of work produces ever more output. Simply; workers become more
productive. Their wages per hour should also rise. Growth rises living standards for workers.
2. Thinking about Economic Growth: Facts and Stylized Facts
Production function = the production function relates the output of an economy –its GDP-
to productive inputs. Most important ones: physical capital stock (K) and labour (L). Y=F(K,L)
The ratio ∆Y/∆K, the amount of new output per unit of incremental capital, is called the
economy’s marginal productivity.
Diminishing marginal productivity = holding labour L unchanged, adding to the capital stock
K allows an economy to produce more, but in smaller and smaller increments.
Constant returns to scale: when capital and labour were both doubled, and the production
function also doubled.
Increasing returns to scale: if a doubling of inputs leads to more than a doubling of output.
Decreasing returns to scale: when output increases by less than 100%.
A property of constant returns production function emerges: output per hour of work – the
output-labour ratio (Y/L) - depends only on capital per hour of work - the capital-labour
ratio (K/L). Production function: y = f(k)
The output-labour ratio Y/L is also called the average productivity of labour: it says how
much, on average, is being produced with one unit of work. The capital-labour ratio K/L
measures the capital intensity of production.
Because of diminishing marginal productivity, the curve (y=f(k)) becomes flatter as the
capital-labour ratio increases.
Economist Nicolas Kaldor studied economic growth in many countries over long periods of
time and isolated several stylized facts about economic growth.
Stylized facts = empirical regularities found in the data.
Kaldor’s stylized facts:
Stylized Fact No. 1: both output per capita and capital intensity keep increasing
It seems that GDP to grow without bound. Yet labour input, measured in person-hours of
work (L), grows much more slowly than both capital (K) and output (Y). Put differently, both
average productivity (Y/L) and capital intensity (K/L) keep rising. Because income per capita
(Y/N) is closely related to average productivity or output per hour of work (Y/L), economic
growth implies a continuing increase in material standards living.
Stylized Fact No. 2: the capital-output ratio exhibits little or no trend over time
As they grow in a seemingly unbounded fashion, the capital stock and output tend to track
each other. As a consequence, the ratio of capital to output (K/Y) shows little or no
systematic trend.
Stylized Fact No. 3: hourly wages keep rising
The long-run increases in the ratios of output and capital to labour (Y/L and K/L) mean that,
over time, an hour of work produces ever more output. Simply; workers become more
productive. Their wages per hour should also rise. Growth rises living standards for workers.
