Ch. 9 Outline Increasing productivity faster than pop growth is the only way that the standard of living of the average person in a country can increase. Why do some countries grow faster than others? Ability of firms to expand their operations Financial system: financial markets and financial intermediaries Business Cycle: alternating periods of economic expansion and economic recession. Each period of expansion is no the same length, but every period of exmapsion in US history has been followed by a period of recession, and visa versa. Long-Run Economic Growth: The process by which rising productivity increases the average standard of living. Best measure of standard of living is real GDP per person-read GDP per capita. We measure long-run economic growth by increases in real GDP per capita over long periods of time. It is the upward trend in real GDP per capita that we focus on when discussing lng-run economic growth. Economists today have put increasing emphasis on the need for low-income countries to reduce disease and increase nutrition if they are to experience economic growth. ?Discretionary hours? ? divided between paid work and leisure. Technology and economic growth allow people in the near future to live longer lives, with a smaller fraction of those lives spent at paid work. Growth rate of real GDP during a particular year= % change from previous year. ((GDP2007-GDP2006 )/ GDP2006) x 100. Average annual growth rate: ( GDP in first year) x N= GDP in Final year. Almost exactly equal to taking the average of each years growth rates. Average annual growth rate=growth rate when discussing long-run economic growth. We can judge how rapidly an economic variable is growing by calculating the number of years it would take to double. If it takes 20 yrs, people will see increases in standards of living. If 100 yrs, no. Rule of 70: number of years to double= 70/growth rate (percent). Small differences in growth rates can have large effects on how rapidly the standard of living in a country increases. Increases in real GDP per capita depend on increases in labor productivity Labor Productivity: the quantity of goods and services that can be produced by one worker or by one hour of work. = to output per hour of work. If the quantity of goods and services consumed by the avg person is to increase, the quantity of goods and services produced per hour of work must also increase. What causes labor productivity to increase: the quantity of capital per hour worked and the level of technology. Economic growth occurs if the quantity of capital per hour worked increases and if technological change occurs. Capital: manufactured goods that are used to produce other goods and services. EX: computers, factories, machine tools, warehouses, and trucks. Capital Stock: the total amount of physical capital available to a country. As capital stock per hour increases, worker productivity increases. Human capital: the accumulated knowledge and skills workers acquire from education and training or from their life experiences. Economic change depends more on technological change than on increases in capital per hour worked. Technological change: an increase in the quantity of output firms can produce using a given quantity of inputs.?most from new software, machinery, or equipment. Must have technological change along with new inputs for economic growth to occur. Entrepreneurs: operate a business, bringing together the factors of production (L, K, and natural resources. Finally, government must provide secure rights to private property for economic growth to occur. Every country that has experienced economic growth first experienced a financial revolution. Potential GDP: the level of GDP attained when all firms are producing at capacity. Capacity is NOT the maximum output the firm is capable of producing. Capacity is measured on normal operating hours, not 24/7 for 52 weeks. Potential GDP Will increase over time as the labor force grows, new buildings are built, new machinery and equipment is installed, and technological change takes place. Estimated at 3.5% per year. Actual level of GDP may increase or decrease more or less. Retained Earnings: profits that are reinvested in the firm rather than paid to firm?s owners. Financial system: the system of financial markets (stock and bonds) and financial intermediaries (banks) through which firms acquire funds from households. Financial markets: markets where financial securities, such as stocks and bonds, are bought and sold. Financial Security: states the terms under which funds pass from the buyer of the security to the seller. Stocks: financial sectaries that represent partial ownership of a firm. Bonds: financial securities that represent promises to repay a fixed amount of funds. EX: interest payment every year as well as a final payment of the amount of the loan. Financial Intermediaries: firms, such as banks, mutual funds, pension funds, and insurance companies, that borrow funds from savers and lend them to borrowers, Intermediaries pay interest to savers in exchange for the use of savers? funds to earn a profit by lending money to borrowers and charging borrowers a higher rate of interest on the loans. Mutual Funds: sell shares to savers and then use the funds to buy a portfolio of stocks, bonds, mortgages and other financial securities. Open-end: issue shares that the mutual fund company will buy back at a price that represents the underlying value of the financial securities owned by the fund. 3 key services for savers and borrowers: Risk: chance that value of secutiry will change relative to what you expect. Risk sharing: allows savers to spread money among many financial investments. Liquidity: the ease with which a financial security can be exchanged for money?easily sell stock). Information: facts about borrowers and expectations about returns on securities. THE TOTAL VALUE OF SAVING IN THE ECONOMY MUST EQUAL THE TOTAL VALUE OF INVESTMENT. Relationship between GDP and its components: GDP=Y. Consumption= C. Investment=I. Government purchases= G. Net Export=NX Y=C+I+G+NX GDP is a measure of total production and total income in the economy. Open Economy: interaction with other economies in terms of both trading of goods and services and borrowing and lending Closed economy: no trading or borrowing and lending with other economies. In a closed Economy: NX=0. Y=C+I+G I=Y-C-G Private saving: equal to what households retain of their income after purchasing goods and services (C) and paying taxes (T). Households- receive income from the government in the form of transfer payments (TR). TR= social security, unemployment insurance payments. Sprivate = Y+TR-C-T Public Saving: the government engages in saving. Public saving= the amount of tax revenue the government retains after paying for government purchases and making TR payments. Spublic= T-G-TR Total saving (S)= Sprivate + Spublic OR S= (Y+TR-C-T) + (T-G-TR) OR S=Y-C-G OR S=I. Balanced Budget: gov spends the same amount that it collects in taxes Budget deficit: gov spends more than it collects in taxes T is less than G + TR?public saving is negative, or dissaving. There is a lower level of investment spending in the economy when there is a budget deficit than when there is a balanced budget. Budget surplus: gov spends less than it collects in taxes- increases public saving and the total level of the economy. Higher saving=higher level of investment spending. The market for Loanable Funds: The interaction of borrowers and lenders that determines the market interest rate and the quantity of Loanable funds exchanged. Demand of Loanable funds is determined by the willingness of firms to borrow money, to engage in new investment projects, and development of new products. To determine whether to borrow funds, firms compare the return they expect to make on an investment, with the I. rate they must pay to borrow the funds. Supply of Loanable funds is determined by the willingness of households to save and by the extent of government saving or dissaving. When houses save, they reduce consumption and enjoyment. Higher the I. Rate the more saving will occur from households. The NOMINAL interest rate is the stated interest rate on a loan. We draw the demand curve for Loanable funds by holding constant all factors, other than the I. rate, that affect the willingness of borrowers to demand funds. Increase in the demand for Loanable funds: I. Rate increases and the quantity increases. Both the quantity of saving by households and the quantity of investment by firms have increased. Increasing investment increases the capital stock and the quantity of capital per hour worked, helping to increase economic growth. If the gov increases spending-SUPPLY OF FUNDS SHIFTS TO THE LEFT I. Rate increases and quantity of funds is lower. Running a deficit has reduced the level of total saving in the economy and, has reduced the level of investment spending by firms. Crowding out: a decline in private expenditures as a result of an increase in government purchases. Decline in investment spending due to crowding out. Lower investment spending means that the capital stock and the quantity of capital per hour worked will not increase as much. Government budget surplus= opposite of deficit= increase in total amount of saving in economy, shifting the supply of Loanable funds to the right. I. Rate will be lower and the quantity of Loanable funds will be higher. Budget surplus INCREASES the level of saving and investment. The Business Cycle: real GDP per capita did not increase every year of the last century. Business cycle= movements in real GDP Expansion phase: production, employment, and income are increasing. Ends with a business cycle peak. Recession phase: production, employment and income decline. Ends with a business cycle trough. Inconsistent movements in real GDP around the business cycle peak can mean that the beginning and ending of a recession may not be clear-cut. As the economy nears the end of an expansion, I. rates usually are rising, and the wages of workers usually are rising faster than prices. Profits are falling. Households and firms have increased their debts?the result of borrowing firms and households undertake to help finance their spending during the expansion. A recession will begin with decline in spending by firms on capital goods, such as machinery, equipment, new factories, or by households on new houses and consumer durables. As spending declines, sales decline. Firms then cut back production, lay off workers. Rising unemployment and falling profits reduce income?leading to further declines in spending. As the recession ends, spending declines come to an end; households and firms reduce debt, increasing spending ability; i. rates decline, borrowing increases. Increased spending on consumer durables end the recession and head towards next expansion. Durables (3 or more yrs) are affected more by the business cycle than non-durables During expansions: I. Rate increases, During recession: I. Rate decreases. (particularly at the end of both). Recessions cause the inflation rate to fall, but unemployment to increase. Due to 2 factors: Discouraged workers drop out of and then return to the labor force. Firms continue to operate well below their capacity even after a recession has ended and production has begun to increase. Business cycles have become milder since 1950. Less fluctuations in real GDP sine 1950. Avg. expansion-61 months. Recession-9 months. Why are we more stable? The increasing importance of services and the declining importance of goods. The establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed. Active federal government policies to stabilize the economy.
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