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## AP®︎/College Macroeconomics

# Economic growth through investment

AP.MACRO:

MEA‑1 (EU)

, MEA‑2.B (LO)

, MEA‑2.B.1 (EK)

, MEA‑2.B.2 (EK)

Economic growth is an expansion of the capacity to produce goods and services. Economists traditionally believed that expanding the stock of capital leads to economic growth. In this video, we explore the important link between investment and growth using the PPC model. Created by Sal Khan.

## Want to join the conversation?

- At7:29and7:47Sal mentioned R&D, I know he said it's capital accumulation, but does anyone know what R&D stands for? Thanks

Update: "Research and Development" thanks alot eamonnclifford(45 votes)- R&D means "Research and Development"(57 votes)

- Hang on, isn't the production possibility curve supposed to combine two FINAL GOODS ? In this case, shouldn't the rabbit trap be considered as a factor of production, not as a good that limits possibility of the "production" of the rabbits?(8 votes)
- Investing some time today to make your operation more efficient/productive tomorrow is a real situation that faces most businesses so this discussion by Sal is quite pertinent. You are deciding whether to invest time in catching rabbits or making traps so your production is traps, or rabbits or rabbits/traps. The rabbit trap becomes a factor of production tomorrow.

For example in your warehouse the products you carry are not grouped in logical groups, this maybe due to your business have grown. Presently it takes you 15 minutes to pick a typical order. So that evening you do some thinking and decide that if products in the warehouse were grouped on the shelves in a more logical manner the average time to pick an order would be reduced to 10 minutes. The next evening you do some more thinking and realize you would have to close your business for a whole week to reorganize the warehouse. The question you then ask yourself is will the payback (5 minutes per order) be worth the 1 weeks investment. The decision will be based then upon how many orders you are picking a week to decide if the payback outweighs the 1 week investment.

Believe it or not the most efficient method sometimes is not the best use of resource due to the level of investment required to achieve the optimum level of efficiency. Or as my boss would say "I'm not s[ending $100,000 to save $10,000"(22 votes)

- if everything is ceterus paribus (all held constant) how can the hunter collect all of the rabbits he has at PPF1 if hes spending all his time and effort on hunting the 5 rabbits? or is the time in collecting the rabbit so marginal that it is ignored?(5 votes)
- That's a great point. Probably the curve at PPF1 should have stopped a bit short of 6 rabbits. PPF0 shows that if you spend no time collecting rabbits, your traps give you nothing, Therefore you have to spend some time on collection.
**However**in fairness to Sal, he could argue that in this scenario checking the trap is something you can do for free while you're out hunting for rabbits (but you can't check the trap while you're sitting inside making more traps). So if that's the case then maybe PPF1 really could get all the way to 6.(6 votes)

- just out of curiosity, what kind of variable could the Z axis be? hours of sleep (if hunting 1 rabbit takes a defined amount of time and making one trap takes another defined amount of time)?(4 votes)
- I think you could put berries from the previous videos on the third axis.

Think about it - he is either going to hunt rabbits, improve his rabit hunting techniques (traps) or go to get some fruit.

And sleeping works too: You could ask questions such as how much sleep do you get if you will not hunt 6 but 5 rabits.... What is the marginal benefit of one hour of sleep in terms of one not cought rabbit.(3 votes)

- After you had made the first trap, wouldn't you start getting rabbits without having to hunt for them? On the PPF, it is shown that if the hunter-gatherer spends all their time making traps, they won't get any rabbits, but couldn't they get rabbits without hunting now? What would a PPF with passive production look like?(3 votes)
- We are assuming that, if someone spends ALL their time making traps, they are not having any time left to set up the trap. Hence they will 3 traps but no time to set them up.(3 votes)

- When we were increasing PPF1 to PPF2 so in what point we are now? We were in (2,4) and now we are now? Thanks.(2 votes)
- You can choose any point on PPF2. The message is simply that: if you give up some rabbit consumption today and invest in creating rabbit traps, you will be better off in the future. As opposed to (4,2) on PPF1 you chose for example point (6,2) where you still invest some time into making traps, but you are already enjoying the fruit of your past investment, or you can choose (4,3.5) where invest even more into making traps to enjoy even more rabbits in the future.

All in all, you can choose any point on PPF2, you will be still better off when you had to choose points on PPF1.(3 votes)

- at2:02sal mentions one in three dimensions. What would that look like?(2 votes)
- It will create a 3D image. Looking like a mountain range.(1 vote)

- When Sal starts drawing the PPF1 (at4:24) and PPF2 (at5:19) lines on the graph, he shows that the number of rabbits that the person would catch would still be zero of all he did was make trap, but if he already had 1 or 3 traps made, wouldn't he catch rabbits even if he was making traps and not catching rabbits himself. Is that an error in the graph or am I thinking about it wrong(1 vote)
- You would still need to devote some time to setting the traps and such so that they would actually catch the rabbits. You can't just spend all of your time making traps and yet still catch rabbits.(2 votes)

- how to calculate trend rate of growth?(1 vote)
- what is the main type of investesments and accumulation of capital(1 vote)

## Video transcript

In the last few
videos, we've been talking about the
production possibilities frontier as a relatively
static thing, something that you couldn't change
but you could move along. What I want to do in this
video is think about, maybe there are ways
to change or expand the production
possibilities frontier. And to do that let's assume that
our little hunter-gatherer has decided to become
a strict carnivore. So he's only focused
on rabbits now. And his whole happiness in
life is optimizing the number of rabbits he can catch
and eat in a given day. And so let's-- on
one axis let's draw, let's say the number of rabbits
that he can catch in a given day. Let's say it's 1,
2, 3, 4, 5, 6, 7-- I could keep going on and on. So this right over
here is rabbits that he can catch in a
given day, rabbits in a day. But remember, he wants
to optimize this. He wants to think about how he
can increase his productivity in terms of the
number of rabbits. And he knows-- we'll
just assume that he knows how to build rabbit traps. So now we're going to do
a production possibilities frontier, not between
rabbits and berries, but between rabbits and building
rabbit traps, so rabbit traps. So maybe he's able
to get twigs together and he builds something. Puts the twigs together
in a little thing. It's a little box that--
maybe he puts a little, I don't know some type of
carrot down over there. And then if the rabbit comes
then takes the carrot then the box falls on the rabbit
or something like that. We don't have to go into the
particulars of the actual trap. But he can also spends his
time building rabbit traps. So let's say, 1 rabbit
trap, 2 rabbit traps, and 3 rabbit traps. And let's say-- we're going to
hold all other things equal, ceteris parabus. So we're not worrying
about other things. And as we'll see, in most
introductory economics class, whenever you do a production
possibilities frontier you're only doing it
with two dimensions. And so that's why you
have a regular curve. You could have one with three
dimensions, where you're doing the trade off
between three things. But then you would have to
have a three dimensional graph, and essentially the production
possibilities frontier would be a surface. But let's just focus
on this right now. Maybe I'll do a surface in
the future, just for fun. So these are the rabbit traps. And let's say the production
possibilities frontier between rabbit traps and rabbits
look something like this. He could spend all his
time making rabbit traps, but in that case he
won't get any rabbits and he'll probably starve. And that wouldn't
be a good scenario. Or he could spend all of
this time hunting for rabbits and he would catch, on
average, 5 rabbits per day. But that would leave him no
time to make rabbit traps. So this is our
current production possibilities-- let
me just draw it. This is our current production
possibilities frontier. So I'll call this p, production
possibilities frontier. And I'll put a little
0 subscript there. That's our starting point. So he can he can sit
anywhere over here, and he would have achieved
productive efficiency anywhere on this curve. But as we saw, if he just spent
all of his time doing this over here, he'll never
get any rabbit traps. And so he won't
be able to change the productive
possibility frontier. But what happens if
instead he decides that he does want to
build some rabbit traps? So he decreases the number
of rabbits a day to 4 and that allows him to
make 1 rabbit trap per day. So he wants to hang
out in this scenario. So every day that
goes by, on average, he's going to make 4 rabbits. And he's going to
build a rabbit trap. So what's going to happen? So as we go into, maybe
into the next period, he would now have a rabbit
trap after just one day that he can use to
help catch rabbits. So that will actually change
the production possibilities frontier. So if he makes
this investment, it will actually allow him,
in a given amount of time, to actually catch more rabbits. So if he does that, the
production possibilities frontier-- having a rabbit
trap won't make him that much, won't allow him to make
more rabbit traps in a day. So the most rabbit traps
he can make in a day is still going to be 3. But maybe now he can
catch 6 rabbits a day. So now it might look
something like that. So now he could either
stop making rabbit traps, and catch 6 a day just
with that 1 rabbit trap he has, or he could
continue that. And now actually he can
catch 5 rabbits a day and still make 1
rabbit trap a day. And maybe he decides to do that. But it could be anywhere along
this production possibilities frontier. Or he could say, hey, I'm happy
eating the 4 rabbits a day. I'm going to make 2 rabbit
traps now every day. And now after another period
he gets even more productive. And so then the production--
so let me call this one, this is after one day. Production possibilities
frontier after one day, and then after two
days, let's say he did this scenario
right over here. Now he's produce 2 rabbit traps. And obviously, maybe I'm
exaggerating how quickly his productivity would grow. But maybe now the new production
possibilities frontier looks something like this. He now has 2 rabbit traps. Or he has 2 more rabbit
traps, he already had 1. So now he has 3 rabbit
traps after two days. And so now if he wanted to
devote themselves purely to rabbit trapping he
can get 8 rabbits a day. Or he could do some
combination in between. And actually this curve,
it shouldn't go up at all. I don't want to give
you the impression that it went up and then down. It just goes kind of
straight and does something like that right over here. So this right over
here, I'll call that the production
possibilities frontier 2. So what this hunter-gatherer
is doing in this scenario right here is, he is
making an investment. He is accumulating capital. This right over here,
this is capital. He is choosing, instead of to
consume all of his resources-- so there's two things he can do. He can either spend all of
his time in pure consumption, getting as many rabbits
as possible a day and then eating them
all, pure consumption. Or he could reduce
his consumption and then allocate
some of his resources towards and investment. So this right over here,
this is an investment. It makes him more productive. This right over
here is consumption. There's some base
level of consumption he needs to survive. But if he invests,
then it increases his overall productive capacity. So if you viewed
him as an economy by himself, by investing
instead of consuming all of his resources,
by investing some of his resources--
and in this case, his resources are his
time and his expertise-- by investing some of them
he's able to increase his productivity. And if you viewed
him as an economy, he's experiencing
economic growth. And so there's multiple
types of investments. And we'll talk about
these in multiple videos. In this case, he is doing
capital accumulation. He is building tools that
will make him more productive. Another type of
investment is essentially technological change,
technological improvement, which would actually make
his tools even better. So we could maybe draw another
production possibilities frontier between
making rabbit traps and then doing R&D on inventing
new types of rabbit traps. And so he could decide
which of those two things he wants to decide between. But what I wanted you to
just appreciate in this video is that the production
possibilities frontier can change. You can become more
productive if you do have investment in R&D
or capital accumulation. And in this case, that just
happened to be rabbit traps.