Q. Production function and Growth?
From the simple production function Y = f(L, K), we can classify three sources of growth:
- An increase in L.
- An increase in K.
- A change in the function f
The first two signify growth of the factors of production. L may increase if population grows, if we have more individuals in workforce or if unemployment falls. K increases if investment are large as they are if total savings is large.
Function f need not be the same function over time. It is possible that Y increases albeit L and K are fixed. When f changes so that same amount of the factors of production will produce more output we say that we have technological progress or productivity growth. With technological progress MPL and MPK will characteristically increase for given values of L and K, which is, productivity of the factors increase.
Education and growth in human capital are significant aspects of growth in GDP. Human capital is treated in numerous ways in the literature:
- You can think of human capital as being included in K - with this view education is a type of investment.
- You can add another variable in production function: Y = f(L, K, H) where H is the amount of human capital and K is the amount of physical capital.
- The amount of human capital may affect the function f. The more human capital, the more can be produced from same amount of L and K. With this view, increasing the amount of human capital will result in productivity growth.
Growth Accounting is the activity in which we try to figure out how much of growth in GDP is because of growth in L, growth in K and growth in productivity.