I n t h I s c h a p t e r y o u w I l L

tech-
nological knowledge
—the understanding of the best ways to produce goods and
services. A hundred years ago, most Americans worked on farms, because farm
technology required a high input of labor in order to feed the entire population.
Today, thanks to advances in the technology of farming, a small fraction of the
population can produce enough food to feed the entire country. This technological
change made labor available to produce other goods and services.
Technological knowledge takes many forms. Some technology is common
knowledge—after it becomes used by one person, everyone becomes aware of it.
For example, once Henry Ford successfully introduced production in assembly
lines, other carmakers quickly followed suit. Other technology is proprietary—it is
known only by the company that discovers it. Only the Coca-Cola Company, for
instance, knows the secret recipe for making its famous soft drink. Still other tech-
nology is proprietary for a short time. When a pharmaceutical company discovers
a new drug, the patent system gives that company a temporary right to be the
t e c h n o l o g i c a l k n o w l e d g e
society’s understanding of the best
ways to produce goods and services
Economists often use a 
pro-
duction function
to describe the
relationship between the quan-
tity of inputs used in production
and the quantity of output from
production. For example, sup-
pose 
Y
denotes the quantity of
output, 
L
the quantity of labor,
K
the quantity of physical capi-
tal, 
H
the quantity of human
capital, and 
N
the quantity of
natural resources. Then we
might write
Y
⫽
A F
(
L, K, H, N
),
where 
F
( ) is a function that shows how the inputs are com-
bined to produce output. 
A
is a variable that reflects the
available production technology. As technology improves, 
A
rises, so the economy produces more output from any given
combination of inputs.
Many production functions have a proper ty called 
con-
stant returns to scale.
If a production function has constant
returns to scale, then a doubling of all the inputs causes the
amount of output to double as well. Mathematically, we
write that a production function has constant returns to
scale if, for any positive number 
x
,
x Y
⫽
A F
(
x L , x K , x H , x N
).
A doubling of all inputs is represented in this equation by
x
= 2. The right-hand side shows the inputs doubling, and
the left-hand side shows output doubling.
Production functions with constant returns to scale
have an interesting implication. To see what it is, set 
x
=
1/
L.
Then the equation above becomes
Y / L
⫽
A F
( 1 ,
K / L , H / L , N / L
).
Notice that 
Y / L
is output per worker, which is a measure of
productivity. This equation says that productivity depends on
physical capital per worker (
K / L
), human capital per worker
(
H / L
), and natural resources per worker (
N / L
). Productivity
also depends on the state of technology, as reflected by the
variable 
A
.
Thus, this equation provides a mathematical
summar y of the four determinants of productivity we have
just discussed.
F Y I
The Production