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ECON 1BB3 - Entire Course.docx

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McMaster University
Bridget O' Shaughnessy

Wednesday October 14, 2009—Chapter 7 (Lesson 12) Why are Norwegians better off than Ethiopians?  We are better off if poor countries get richer because we can sell more goods to them. They have a higher GDP per capita and historically this higher GDP per capita has been related to lower mortality rates; higher life expectancy, etc. Productivity  Productivity: the quantity of goods and services that a worker can produce for each hour of work  Determinants of productivity o Physical capital: how much capital each worker has to use o Human capital: what we invest when we get educated; relates to how much time we spend to learn things (e.g. time we spend reading the books in library) o Natural resources: two types; renewable (fish, animal, etc) and non-renewable (oil, coal, iron, etc.) o Technological knowledge: our knowledge of how to combine inputs to produce output (e.g. books in library) Production function  Production function: shows how we combine inputs to produce output o Y = A * F (K, L, H, N)  aggregate  Y = output  A = technology  K = physical capital  L = labour  H = human capital  N = natural resources  F = is a function of  If a production function exhibits constant returns to scale, then doubling all inputs leads to a doubling of output o 2Y=A*F(2K, 2L, 2H, 2N) o 100Y=A*F(100K, 100L, 100H, 100N) – 100 times as much output o xY=A*F(xK, xL, xH, xN) o Y/L=A*F(K/L, 1, H/L, N/L) per worker  Diminishing marginal product o Product: output o Marginal product: the extra output produced by increasing an input by 1 unit o Diminishing marginal product: the extra output produced by adding the 19 unit of labour is smaller than the extra output produced by adding the 18 unit of labour  Catch-up effect o Catch-up effect: poor countries tend to grow faster than rich countries (e.g. China right now; Germany and Japan after WW2) o An increase in the saving rate does not lead to a permanent increase in the growth rate; it does lead to an increase in the level of GDP per capita but the growth rate does not stay high forever. o Assumptions made:  constant returns to scale – means that we can draw our function in per capita terms  diminishing marginal product – shape of function Policies  What can government policy do to raise productivity and living standards? o Encourage saving (increase K)  Consume less and save more; there is an increase in investment spending  e.g. impose a consumption tax o All foreign investment (increase K)  Building factories or buy stocks in foreign countries o Spend on education (H)  More educated individuals = more ideas for society  Brain drain problem: emigration of highly educated people to rich countries o Improve property rights and reduce political instability (K,A)  Will lead to more investment which means more capital and can also lead improvements in technology. People will not invest in a country if they think that someone can come along and take the profits – strong legal system is needed; contracts need to be enforced so that people would be willing to take risks and invest o Free trade (A)  Can be a substitute for technology (e.g. growth in Japan and Korea after WW2 happened this way; imported high-tech goods from US, learned how to make them more cheaply and exported them back to the States) o Research and Development – R&D (K,A)  Grants (e.g. Funded research at university)  Patent system which allows the profits to the new invention to go to the discoverer or inventor; enhances the incentive for individuals and firms to engage in research Monday October 19, 2009 – Chapter 8 (Lesson 13) What do the terms ‘saving’ and ‘investment’ mean to an economist?  Investment – purchases of new physical capital (e.g. machinery, equipment, buildings, etc.). Investment does not refer to purchasing stocks and bonds.  Remember: investment (I) = national savings (S) Final institutions  Financial markets: borrowers and savers are directly linked o Bond market  Loan – purchasing a bond (making a loan to a company or the government)  Bonds are issued by governments and large businesses; since it is a loan, they pay a rate of interest  The rate they pay depends on the term (longer terms  higher interest) and risk (higher risk higher interest) o Stock market: buying stock, buying part ownership of a company  When you are purchasing a stock, you are purchasing part ownership of the firm  Why buy stocks: When the firms make a profit, you will get a share of these profits (called dividends). Also opportunity for capital gain (buying a stock at a certain value to sell it at a higher value). However there is also the risk of suffering a capital loss  The return on stocks is greater than bonds because:  Stocks riskier - capital loss  Bankruptcy laws - protect bond holders before stock holders  Financial intermediaries: indirectly linked savers and borrowers o Banks  Provide loans  Deposits from savers o Mutual funds  People with small amounts of money pool together to buy stocks  e.g. Google, 1 stock is valued at 500$ Saving and investment (chapter 8 deals with a closed economy)  C (consumption); I (investment); T (taxes); Y (income)  National income accounting identity: (no NX because looking at a closed econ) o Y = C + I + G  Private saving:pS = Y - T - C  Public (government) saving: g = T - G o Budget surplus: T>G o Budget deficit: GC then at the end of every period you have some savings (flow variable); your wealth or assets is the stock variable that is the sum of all past saving. How we hold this stock of wealth or assets is a decision we have to make based on several things (money, bonds, stocks)  M – vertical – position is determined by the central bank. The central bank doesn’t actually control the quantity of money in the economy; we’re going to assume it does to make our model easier. Two things limiting the banks control: o Central bank can set a minimum legal reserve requirement but if a bank chooses to excess reserve, there is nothing the bank can do about it o Households decide what share of the money to hold in the form of currency or the form of deposits. The larger the share of deposits in our total money holdings, the larger the money supply will be.  Suppose the central bank increases the money supply – M increases, value of money decrease and price level would increase Quantity theory of money  Quantity theory of money: o The quantity of money determines the price level o The growth rate of money determines the inflation rate  Classical dichotomy: the separation of real and nominal variables  Monetary neutrality: changes in M affect nominal variable, but not real variables Velocity  Velocity: the rate at which money changes hands o Example:  Produce 2,000 cups of ho
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