Over decades, Nominal and Real GDP per person has risen many times over in the richest countries. That is growth of the economy's capacity, the outward shift of the production possibilities curve. Where does it come from?
Key idea
Labor productivity is real output per hour of work. Real GDP = output per hour × hours worked, so real GDP grows by about the growth of productivity plus the growth of hours. Lasting gains in living standards come from productivity, which rises with physical capital (machines, buildings, equipment), human capital (skills and education) and technology (better ways of producing).
Why it works
More hours of work raise output, but there are only so many hours in a week, and more work means less leisure. Output per hour has no such limit. A worker with a better tool, more training, or a smarter method produces more in the same hour. Capital alone runs into diminishing returns: the tenth machine per worker adds less than the first. Technology lifts the whole relationship, so the same capital and skills produce more. That is why economists see new ideas as the deepest source of long-run growth.
Worked examples
Worked example: Output per hour
A country produces \$12,000 billion of real GDP with 200 billion hours of work. Find labor productivity.
- $\dfrac{12{,}000 \text{ billion}}{200 \text{ billion hours}} = 60$ dollars per hour.
- Each hour of work produces \$60 of real output on average.
Answer: \$60 per hour
Worked example: Splitting growth
Productivity grows 2% a year and hours grow 1% a year. How fast does real GDP grow? How much of it raises output per hour?
- Real GDP growth $\approx 2\% + 1\% = 3\%$.
- Only the 2% from productivity raises output per hour, the part that lifts living standards.
Answer: About 3%; 2% from productivity
| Source | Example |
|---|---|
| Physical capital | faster trucks, robots on an assembly line, new office buildings |
| Human capital | a welding course, more students finishing college |
| Technology | a cheaper way to make solar panels, better software |
Common mistake
Crediting growth to more hours of work alone, and missing that lasting gains in living standards come from more output per hour. Check: divide output by hours; if output per hour is flat, people are richer only because they work more.