ECO 205 - Chapter 10 [Economic Growth, the Financial System, Business Cycles]
When spending decreases and a recession is underway, it affects different segments of the economy in different ways. It usually impacts the purchases of durable goods more so than non-durable goods. Purchases of autos and heavy machinery may be postponed, but not food and clothing purchases.
"Which of these would you not cut back on the least during a recession?" - yachts - diamond earrings - diapers - caviar --> the answer is diapers. THUS, during a recession, it's the luxury items that are affected the most.
Calculating Growth Rates
- If Real GDP per Capita in a country doubles, say, every 20 years, most people in the country will experience significant increases in their standard of living over the course of their lives. - if real GDP per capita doubles only every 100 years, increases in the standard of living will occur too slowly to notice.
After a recession is called an 'expansion'. Once the expansion peaks, it starts slowing down which is called a 'recession'. A severe recession is called a 'depression'.
- There have been 10 recessions. - Recessions last between 6-18 months, aka about a year. - Recessions are normal and expected - there is no such thing as a recession that is less than 6 months. A recession HAS TO be at least 2 consecutive quarters of 1 term.
In analyzing C and I, we will simplify the process by assuming that we have a private, closed economy where government expenditures, taxes, and exports and imports are equal to zero. We will also assume that all savings consist of personal savings and that depreciation and net foreign income equal zero.
- all spending in the economy comes from consumers and businesses only --> C + I 1. 2. we have a closed economy (don't participate in international trade)
These assumptions have two implications:
1. Aggregate spending consists of only C + I 2. GDP = Disposable Income
There are two fundamental ways to increase real output and real income:
1. By increasing the amount or number of resources. 2. By increasing the productivity of the resources.
Why are some countries incapable of rapid growth?
1. Failure to enforce the rule of law 2. Wars and revolution 3. Poor public education and health 4. Low rates of saving and investment
Increased productivity of resources occurs when:
1. The health, training, education and motivation of workers improves. 2. When workers have more and better machinery and natural resources. 3. When production is better organized and managed. (Like Ford and the assembly line) 4. When labor is reallocated from less efficient industries to more efficient industries.
Why the United States has been more productive than European Countries.
1. we have about a 20% higher portion of our population that are in the workforce than in Europe. 2. the typical american worker works about 20% more hours per year than the typical European worker.
Crowding Out
A decline in private expenditures as a result of an increase in government purchases. - By borrowing to finance its budget deficit, the government will have crowded out some firms that would otherwise have been able to borrow to finance investment.
Rule of 70
A easy way to calculate approximately how many years it will take real GDP per capita to double.
What determines the rate of long-run growth?
A key point in explaining long-run growth is that increases in real GDP per capita depend on increases in labor productivity.
Price Level
A measure of the average prices of goods and services in the economy.
MPC + MPS = 1 ***KNOW FOR TEST TO PLUG IN****
APC + APS = 1 ***KNOW FOR TEST TO PLUG IN****
APC = consumption / income APC --> average propensity to consume
APS = savings / income APS --> average propensity to save
Business Cycle
Alternating periods of economic expansion and economic recession.
The higher the interest rate, the greater the reward for saving and the larger the amount of funds households will save. Therefore, the supply curve for loanable funds is upward swing because the higher the interest rate, the greater the quantity of saving supplied.
An increase in the quantity of loanable funds means that 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 increase economic growth.
Rule of 70 is used to determine how long it takes an investment to double: the number of years to double = 70 / annual growth rate
EX: If Real GDP Per Capita is growing at a rate of 5 percent per year, it will double in 70/5 = 14 years.
What causes labor productivity to increase?
Economists believe two key factors determine labor productivity: 1. The quantity of capital per hour worked 2. The level of technology THEREFORE, economic growth occurs if the quantity of capital per hour worked increases and if there is technological change.
Financial Intermediaries
Firms, such banks, mutual funds, and insurance companies, that borrow funds from savers and lend them to borrowers.
If your income goes from 100,000 to 150,000 ....
IT IS DECREASING LESS THAN 5%. [TEST QUESTIONNNNN]
STOCKS are financial securities that represent partial ownership of a firm.
If you buy one share of stock in Whirlpool, you become one of millions of owners of that firm.
Human capital refers to the accumulated knowledge and skills workers acquire from education and training or from their life experiences.
Increases in human capital are particularly important in stimulating economic growth.
MPC = the fraction of any change in income that is consumed.
MPC = the change in C / the change in income
MPC (marginal propensity to consume) = (change in consumption) / (change in income)
MPS = (change in saving) / (change in income) MPS --> marginal propensity to save
MPS = the fraction of any change in income that is saved.
MPS = the change in S / the change in income
Capital
Manufactured goods that are used to produce other goods and services. EX: computers, factory buildings, machine tools, warehouses, and trucks. The total amount of physical capital available in a country is known as the country's capital stock. - as the amount of capital per hour worked increases, worker productivity increases.
Financial Markets
Markets where financial securities, such as stocks and bonds, are bought and sold.
The level of GDP is mainly determined by the level of aggregate or total expenditures in the economy. The more C + I + B + S the more products that will be produced (because more consumption spending).
More spending = higher levels of GDP Less spending = lower levels of GDP
Prior to the 1800s, virtually every country in the world was the same. 90% were peasants.
Once it hit the 1870s, the United States GDP per capita began to grow.
In the U.S., real GDP grew at annual average rates of about 3.5%. From 1950 - 2013 the published number is 3.3%. Why?
Real GDP has gone up and down as it has increased over the years.
Mutual Funds
Sell shares to savers and then use the funds to buy a portfolio of stocks, bonds, mortgages, and other financial securities.
Economic growth depends more on technological change than on increases in capital per hour worked.
Technology refers to the processes a firm uses to turn inputs into outputs of goods and services. Technological change is an increase in the quantity of output firms can produce, using a given quantity of inputs. Technological change can come from many sources. Most technological change, however, is embodied in new machinery, equipment, of software.
Market for Loanable Funds
The interaction of borrowers and lenders that determines the market interest rate and the quantity of loanable funds exchanged.
Potential GDP
The level of real GDP attained when all firms are producing at capacity. - the capacity of a firm is not the maximum output the firm is capable of producing. - Potential GDP increases over time as the labor force grows, new factories and office buildings are built, new machinery, and equipment are installed, and technological change takes place.
Long-Run Economic Growth
The process by which rising productivity increases the average standard of living. - the best measure of the standard of living is real GDP per person, which is usually called real GDP per capita. - So, we measure long-run economic growth by increases in real GDP per capita over long periods of time, generally decades or more. - we use real GDP rather than nominal GDP per capita in the price level over time. - The trend in real GDP per capita is strongly upward, although it fluctuates in the short run because of the business cycle.
Labor Productivity
The quantity of goods and services that can be produced by one worker or by one hour of work.
Financial System
The system of financial markets and financial intermediaries through which firms acquire funds from households. - Without a well-functioning financial system, economic growth is impossible because firms will be unable to expand and adopt new technologies.
BONDS are financial securities that represent promises to repay a fixed amount of funds.
When Whirlpool sells a bond, the firm promises to pay the purchaser of the bond an interest payment each year for the term of the bond, as well as a final payment of the amount of the loan.
Growth reduces the burden of scarcity.
When real GDP goes up, the standard of living goes up.
When spending increases --> employment increases --> which makes output increase -->thus, income increases --> and profits increase
When spending decreases, businesses cut back on outputs and profits decrease --> which makes income decrease --> which makes employment decrease.
The total value of saving in the economy must equal the total value of investment.
When the government spends the same amount that it collects in taxes, there is a balanced budget. When the government spends more than it collects in taxes, there is a budget deficit. --> this makes public saving negative. - Negative Saving is also known as --> dissaving When the gov spends less than it collects in taxes, there is a budget surplus.