Empirical Estimates of the Aggregate Production Function

Now that we have examined the principles of production theory, we can apply these theories to measure how well the whole U.S. economy has been performing. To do this, we need to look at the aif;rtgale production functions, which relate total output to the
quantity of inputs (like labor, capital, and land) and  to total productivity. What have economic studies found? Here are a few of the important results:

• Total factor productivity has been increasing throughout this century because of technological progress and higher levels of worker education and skill. The average rate of total productivity growth has been slightly under 1~2 percent per year tluring the twentieth century.
• The capital stock has been growing faster than the number of worker-hours. As a result, labor has a growing quantity of capital goods to work with; hence labor productivity and wages have tended to rise even faster than the 1}’2 percent per year attributable to total factor productivity growth alone.
• The rate of return on capital (the rate of profit) might have been expected to encounter diminishing returns because each capital unit now has lessIabor to cooperate with it. In fact, capital’s rate of return has remained about the same.
• Over the twentieth century, labor productivity grew at an average rate of slightly more than 2 percent per year. From the early 1970s to the mid-  19905, however, all measures’ of productivityshowed a marked growth slowdown, and real Wages and living standards consequently stagnated over this period. Since the mid-I990s, fueled largely by the computer revolution, there has been a marked upturn in productivity growth, with rates close to the histori~al norm.

A final encouraging word: Although measured productivity growth has been slow in the last few years, recent empirical studies suggest that we have seriously underestimated productivity growth. Studies of medical cart’, capital-goods pricing. computer software, and lighting indicate that our measuring rod for productivitv may be badly flawed. One particularlv important shortcoming is the failure to account for the economic value of new products. For example, when compact discs replace records, our measures of productivity do not include the improvement in durability and sound quality, One study found that productivity in treatment of heart attacks was 5 percent per year more rapid than the conventional measures. If further studies confirm these tentative conclusions, we may find that productivity growth over the last quarter-century was significantly faster-maybe even double-the meager % percent per year reported in the official statistics.

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