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5.7 End-of-Chapter Material

In Conclusion

We began the chapter with five stories from all around the world. Let us briefly review these stories, based on what we have learned in this chapter.


Niger is an extremely poor country. Life expectancy in Niger is 52, the infant mortality rate is over 10 percent, and less than 30 percent of the population can read and write. It is extremely poor because it lacks the key inputs to the production function. It is largely a subsistence agricultural economy: it has relatively little physical capital or human capital, little physical infrastructure, and poor social infrastructure as well. It is a natural target for World Bank help. The particular World Bank project that we cited is aimed at one particular input: its goal is to improve Niger’s human capital.


In a globalized world, savings and investment do not have to be equal in any individual economy. Savers can send their funds almost anywhere in the world in search of a high return on capital. Countries that are competitive, in the sense that they have a high marginal product of capital, will tend to attract such funds. One manifestation of these flows of capital is that multinational companies establish factories where they can produce most cheaply. In the story, we see that Vietnam, a low-wage economy, is attracting capital investment from a Taiwanese company. Capital flows have a similar effect to the migration of labor: when capital flows into a country, it increases the real wage; when capital flows out of a country, real wages decrease. Globalization benefits the world as a whole, but many individual workers may lose out.

United Arab Emirates

The policies of Dubai are straightforward to understand in the framework of this chapter. Dubai is actively trying to import foreign physical capital and human capital. It is encouraging multinational firms to establish operations in the country. This makes sense because, as we now know, increased physical and human capital will both tend to increase the marginal product of labor in Dubai, leading to higher wages and higher prosperity. Dubai’s claims of attractiveness rest largely on its social infrastructure.

The United Kingdom

Migrant workers are a global phenomenon, be they Poles traveling to England, Mexicans moving to the United States, or Filipinos moving to Saudi Arabia. Like the young Poles in this story, they move from country to country in search of higher wages. Worker migration across national boundaries tends to equalize wages in different countries. As workers leave Poland, for example, labor becomes scarcer there, so wages in Poland tend to increase. When they arrive in the United Kingdom, there is more labor supplied to the United Kingdom labor market, so wages there tend to decrease. However, labor migration is still quite limited because (1) countries restrict immigration and (2) most workers still do not want to suffer the upheaval of moving to a different country and culture.

United States

The competitiveness initiatives of President Obama and President George W. Bush are designed to increase both human capital and knowledge within the United States. They include measures to strengthen education (human capital), increase research and development (R&D; knowledge), and encourage entrepreneurship and innovation. We have seen that the idea of competitiveness is subtle: nations do not compete in the same way that countries do. Still, improvements in technology and human capital will tend to increase the marginal product of capital, making the United States a more attractive place for investment. In that sense, they do make the country more competitive.

Key Links


Table 5.3 An Example of a Production Function

Output Capital Labor Human Capital Technology
10 1 1 10 10
20 2 2 10 10
20 4 1 10 10
20 1 4 10 10
30 9 1 10 10
30 1 9 10 10
30 3 3 10 10
40 2 8 10 10
40 8 2 10 10
40 4 4 10 10
40 4 4 20 5
40 4 4 5 20
80 4 4 20 20
  1. By comparing two different rows in the preceding table, show that the marginal product of labor is positive. Make sure you keep all other inputs the same. In other words, find two rows that show that an increase in labor, keeping all other inputs the same, leads to an increase in output.
  2. By comparing two different rows in the preceding table, show that the marginal product of human capital is positive. Again, make sure you keep all other inputs the same.
  3. By comparing two different rows in the preceding table, show that the marginal product of technology is positive.
  4. Does the production function exhibit diminishing marginal product of physical capital? [Hint: if more and more extra capital is needed to generate the same increase in output, then there is diminishing marginal product.]
  5. Does the production function exhibit diminishing marginal product of labor?
  6. (Difficult) Can you guess what mathematical function we used for the production function?
  7. Why are electricians not paid the same amount in Topeka, Kansas, and New York City? Why are electricians not paid the same amount in North Korea and South Korea? Is the explanation the same in both cases?
  8. Think about the production function for the university or college where you are studying. What are some of the different inputs that go into it? Classify these inputs as physical capital, human capital, labor, knowledge, natural resources, and social infrastructure. Try to come up with at least one example of each.
  9. Suppose government spending is 30, government income from taxes (including transfers) is 50, private saving is 30, and lending to foreign countries is 20. What is national savings? What is investment?
  10. Explain how it is possible for investment to be positive yet for the capital stock to fall from one year to the next.
  11. Is a fireworks display nonrival? Nonexcludable?
  12. Suppose that a country’s capital stock growth rate is 8 percent, the labor hours growth rate is 4 percent, the human capital growth rate is 2 percent, and the technology growth rate is 3 percent. The parameter a is 0.25. What is the output growth rate?
  13. Suppose that a country’s capital stock growth rate is 4 percent, the labor hours growth rate is 3 percent, the human capital growth rate is 1 percent, and the output growth rate is 5 percent. The parameter a is 0.5. What is the technology growth rate?
  14. Explain why a decrease in a country’s competitiveness can be a sign that the country is becoming more prosperous.
  15. Firms are sometimes willing to pay for training courses for their workers. Other things being equal, do you think a firm would prefer to pay for one of its employees to do a general management course or a course that trains the employee in the use of software designed specifically for the firm? Explain.

Economics Detective

  1. Go to the website of the Bureau of Labor Statistics ( Find the median hourly wage in the state in which you live. (If you do not live in the United States, pick a state at random.)

    1. How does it compare to the median hourly wage for the country as a whole?
    2. Which is higher in your state—the median wage or the mean wage? Can you explain why?
  2. Find an example of a competitiveness initiative in some country other than the United States. How will the proposed policies help to attract capital?