Page 19 - FINAL CFA II SLIDES JUNE 2019 DAY 4
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LOS 12.d: Distinguish between capital deepening investment READING 11: CURRENCY EXCHANGE RATES: UNDERSTANDING EQUILIBRIUM VALUE
and technological progress and explain how each affects
economic growth and labor productivity.
MODULE 12.1: GROWTH FACTORS AND PRODUCTION FUNCTION
FACTOR INPUTS AND ECONOMIC GROWTH
where:
The effect of capital investment on economic growth (Y)
and labor productivity can be modelled using, α and (1 − α) = the share of output allocated to capital (K) and labor (L), respectively
Cobb-Douglas production function: (are called capital’s and labor’s share of total factor cost, where α < 1]
Y = TK L T = a scale factor that represents the technological progress of the economy (total
α (1–α)
factor productivity (TFP))
Exhibits constant returns to scale - increasing K
or L by a fixed % leads to the same % increase Y!
Labour productivity = output per worker = Y/L = T(K/L)α = GDP per capita = standard of living measure.
If # of workers and α remain constant, increases in output can be gained by:
• Increasing capital per worker (capital deepening); or
• Improving Technology (increasing TFP). But α < 1, additional capital has a diminishing effect on productivity!
For developed countries, the capital per worker ratio is relatively high (level
C ) so they gain little from capital deepening and must rely on technological
1
progress for growth in productivity.
In contrast, developing nations often have low capital per worker ratios (e.g.,
C ) so capital deepening can lead to at least a short-term increase in
0
productivity.
