Question

Explain what would instantly occur to Natural Real GDP given productivity rose by 1%. Then what would happen to the output ratio as a result? Why? What would we expect to happen to inflation given this effect on the output ratio. Please include explanations. Thank you.

Answer 1

If the productivity is increased by 1% then firstly, there will be a productivity improvement which implies that labour can be released from one industry and be made available for another – for example, rising efficiency in farming will increase production yields and provide more food either to export or to supply a growing urban population and secondly, in economy there will be a rate of growth of productivity which will further lead to an increase in the national output leading to an increase in the Natural Real GDP.

When there is an increase in productivity there is a direct effect on employment and economy which help country to develop and a increase in income. As a result there would be a significant increase in the output ratio (capital output ratio) (capital output ratio is the amount of capital needed to produce one unit of output) and thus a increase in capital output ratio can also be observed.

As there is an increase in output there would be a significant change in the inflation also. Inflation will relax so long as the rate of productivity is increased and also increased productivity will help to cool down the inflation while maintaining the nation's commitment to high levels of employment. For instance, there is 5% productivity growth and 5% growth expected growth in real income, inflation will stabilize at a constant rate until of the main variable changes by its own.

Productivity gains are vital to long term growth, because they give higher incomes with a significant increase in employement leading to a rise in demand.