♪ [music] ♪ - [Alex] Here's a fact
about economic growth that might seem counterintuitive. During World War II, Germany
and Japan suffered heavy losses. Millions of people were killed. Entire cities were flattened.
Roads, bridges, factories, and other resources critical
to an economy were destroyed. Yet, following World War II, Germany and Japan
both grew quickly. In fact, they grew much faster
than did the United States. Many people wondered
what was going on. Why were the losers
of the war growing faster than the winners? Here's another puzzle. In the past several decades, China has been growing
at astonishing rates of growth -- 7 to 10% per year.
Remember, at those rates, the standard of living --
it's doubling every 7 to 10 years. In contrast, in the advanced
economies, like the United States, Canada, or France, they're growing
around 2% per year, doubling only once every 35 years. So here's the puzzle. In the previous talks,
we said that the way to get a high standard of living
and economic growth is to have good institutions,
like property rights, honest government,
political stability, a dependable legal system,
and competitive and open markets. But in each one of these cases,
there's no question that the advanced economies
have better institutions than does China. Plus, the advanced economies --
they've got more human and physical capital. So if the advanced economies
have got better institutions and more capital, why are
they growing slower than China? To solve these puzzles,
we're going to be drawing on an important economic model:
the Solow Model of Economic Growth, named for Robert Solow,
who won the Nobel Prize. The Solow Model
will help us to better understand the dynamics of growth. The Solow Model is
also going to help us to draw a distinction
between two types of growth: catching up growth
and cutting edge growth. As we'll see, catching up can be
much faster than growing on the cutting edge.
Now, you might ask, "What's an economic model?" An economic model is
a simplified framework that helps us to understand
a more complex reality. We're going to be using
a super simple version of the Solow Model
that boils economic growth down to just a few key variables
and some basic mathematics. Now, although it's simple,
the Solow Model can provide us with some deep insights
into the causes of growth. A key part of the model is
a production function -- a simplified description
of how resources, inputs, are used to produce output. So let's take a look
at some of the inputs into our production function. The first key input is us, people. We use the letter "L"
to represent labor. The more educated people are,
the more effective their labor. So we can multiply L
by "e" for education. Together, these two variables
represent human capital. Next up is physical capital,
represented by the letter "K." K is all of our factories,
and tools, and so forth. Last, but certainly
not least, is ideas, represented by the letter "A." A represents all of our knowledge
about how to combine capital and labor to produce
valuable output. Everything from how to transport
stuff without carrying it on your back, to how
to keep diseases from spreading, to how to add up 1,000 numbers
in a fraction of a second. A is ideas, and better ideas mean
that we can get more bang for our buck, more output
from the same inputs of capital and labor. We can think of human capital,
physical capital, and ideas being used together
to produce output. That's the idea
of our production function. Now, right now our production
function is very abstract. But in future videos, we're going
to boil it down even more and make our production
function concrete. We're going to start
in the next video by taking a closer look at how capital --
machines, factories, roads, and so forth -- how capital
contributes to economic growth. Let's dig in. - [Announcer] If you want to test
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