Question

8. Present an analysis that shows how an increase in labor productivity (perhaps from more investment or perhaps from improved technology) will tend to impact the economy. Identify which of your results fit what we actually observe for the U.S. economy over time. Complete your answer to this question by identifying one economic policy you think will help enhance labor productivity. When analysis is warranted, more credit will be given for answers that use the diagrams presented in class. More credit will also be given for answers that include a “story” providing an intuitive explanation of the situation

Answer 1

Each country, has limited resources for being able to fulfil its domestic demand for goods and services. Over time, the demand for goods and services will only increase. This is because the total population of a country would see expansion. If then, we do not control the supply lines and increase the same, it leads to inflation in the country wherein the price levels begin to increase.

The only way out is to increase the productivity of the labour force. Increase in productivity mean, that with the same resources, the output begins to increase in the country.

The United States has been the pioneer in doing so. When we see companies such as Microsoft, Apple and other over the years, with the same available resources, they have been continuing to increase the technology which has resulted in enhanced production and better gains for the society at large.

Increase in labour productivity leads to a situation wherein, the total aggregate supply or the total goods and services produced in a country exceed domestic demand. As a result, the country has enough to be given away as exports and it gains in foreign exchange as the demand for the currency increases.

We have the US dollar as the prime example. Since the amount of goods and services being exported by the United States have increased over time, the prices domestically are lower and have been able to fulfil demand on one hand, and on the other hand the exports have increased and the value of dollar has also increased as countries continue importing from the United States.

The core policy, which enhances labour productivity is that of education. We see examples of countries such as India and China, which through increased expenditure on education, have enabled the success of their societies. They have been overly productive and have had double digit growth rates, primarily because of this increase.

The same is explained through the help of a diagram which is as follows: -

Here, we see that the price level changes from price P1 to P2 as the Labour productivity gives a boost to the Aggregate Supply which shifts from Initial Supply Curve to New Supply Curve. The Aggregate Demand also sees a shift from Q1 to Q2.

The Equilibrium changes from the intersection of P1 Q1 to the intersection of P2 Q2 respectively.

Please feel free to ask your doubts in the comments section.