Question

Define and explain what Aggregate Production Function is. What does it include? Describe each of the factors and what impact it specifically has on productivity. How do each of the factors interact with each other? What countries would relate to the following examples: LDC (Less Developed Countries); NI (Newly Industrialized); and D (Developed)?

Answer 1

Aggregate Production function is a neoclassical interpretation of the Output(Real GDP) in long term based on the various kind of inputs. These inputs are Capital accumulation, Labor and increase in productivity(generally understood by technological progress).This is represented in the form of Cobb Douglas function.

Y = A × K^a × (L × H)^{(1 −a)}

Y = Real GDP

K = capital

L = labor or population level

H = Human capital

A= factors inculcating impact of technology and natural resources.

if a> 0.5 => Capital intensive economy => Capital growth has higher impact on Real GDP growth

if a<0.5 => labor intensive economy => labor and skill growth has higher impact on Real GDP growth

for LDC,

a is generally lower than 0.5=> higher labor dependence.

H is low due to lower standard of human capital(skills and knowledge)

A is also low due to lower levels of technological progress

for NI,

A and H are higher which increases Y. Their Real GDP growth rate is higher due to higher inflow from production and savings as compared to ooutflow in depreciation.

for D,

Every thing is at higher levels with higher levels of skills and technology, higher dependence of capital etc. their growth rate start to decline as in steady state the depreciation outflow is generally higher than production and savings inflow.