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Consider a hypothetical small island nation in which the only industry is weaving

3. Productivity and growth policies

Consider a hypothetical small island nation in which the only industry is weaving. The following table displays information about the economy over a two year period.

Complete the table by calculating physical capital per worker as well as labor productivity.

Hint: Recall that productivity is defined as the amount of goods and services a worker can produce per hour. In this problem, measure productivity as the quantity of goods per hour of labor.

YearPhysical CapitalLabor ForcePhysical Capital per WorkerLabor HoursOutputLabor Productivity
(Looms)(Workers)(Looms)(Hours)(Tapestries)(Tapestries per hour of labor)
203130010035,00045,0009
203248012044,20050,40012

Explanation

Physical capital per worker is equal to the ratio of physical capital to labor:

Physical Capital per Worker in 2031=  Physical Capital in 2031/ Labor in 2031
=300 looms/ 100 workers
3 looms per worker
Physical Capital per Worker in 2032=Labor in 2032Physical /Capital in 2032
480 looms / 120 workers
4 looms per worker

An economy’s labor productivity is equal to the ratio of output to labor hours devoted to the production of the output:

Labor Productivity in 2031 =Output in 2031 / Labor Hours in 2031
 =45,000 tapestries / 5,000 hours of labor
 =9 tapestries per hour of labor
Labor Productivity in 2032 =Labor Hours in 2032 / Output in 2032 Labor Hours
 =50,400 tapestries / 4,200 hours of labor
 =12 tapestries per hour of labor

Based on your calculations, an increase   in physical capital per worker from 2031 to 2032 is associated with an increase   in labor productivity from 2031 to 2032.

Explanation

The changes in the small economy’s physical capital per worker and labor productivity from one year to the next illustrate the general principle that a higher level of capital per worker leads to higher labor productivity. When each worker has more equipment and tools to work with, each worker will generate more output per hour of labor. On the other hand, if each worker has a smaller amount of equipment and tools to work with, each worker will generate a smaller amount of output per hour of labor.

Suppose you’re in charge of establishing economic policy for this small island country.

Which of the following policies would lead to greater productivity in the weaving industry? Check all that apply.

a) Sharply increasing the interest rate on student loans to people pursuing advanced degrees in weaving

b) Encouraging saving by allowing workers to set aside a portion of their earnings in tax-free retirement accounts

c) Imposing restrictions on foreign ownership of domestic capital

d) Subsidizing research and development into new weaving technologies

Explanation:

Productivity, or output per unit of labor input, is determined by four primary factors:

1.Human capital per worker
2.Natural resources per worker
3.Physical capital per worker
4.Technological knowledge

Improving the health and education of the workforce will improve human capital per worker; reducing access to education by raising the interest rates on student loans will not. Promoting research and development will help to expand technological knowledge. Encouraging saving will expand the pool of savings available for investment in physical capital. Taxing the acquisition of capital and restricting foreign direct investment will reduce the amount of physical capital per worker.

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