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Lecture 4

# ECN 204 Lecture Notes - Lecture 4: Real Wages, Diminishing Returns, Potential Output

Department
Economics
Course Code
ECN 204
Professor
Eric Kam
Lecture
4

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Gowtham Kirupakaran
February 8th, 2017
ECN204-011
Week 4 Lecture Chapter 22
The Basics of Economic Growth
Economic growth is the sustained expansion of production possibilities measured as the
increase in Real GDP over a given period
We want to make sure it is constantly increasing
Calculating Growth Rates
The economic growth rate is the annual % change of Real GDP
The economic growth rate tells us how rapidly the total economy is expanding
The standard of living depends on the Real GDP per person
Real GDP per person is Real GDP divided by the population
Real GDP per person grows only if real GDP grows faster than the population grows
Economic Growth versus Business Cycle Expansion
Real GDP can increase for two distinct reasons:
- The economy might be returning to full employment in an expansion phase of the
B/C
- -The economy getting richer
- Potential GDP might be increasing
- -The economy growing
The retur to full eploet is a epasio phase of the B/C is’t ecooic growth
The expansion of potential GDP is economic growth
Growth is when the economy puts out more
The Magic of Sustained Growth
The Rule of 70 states that the number of years it takes for the level of a variable to
double is approximately 70 divided by the annual % growth rate of the variable
- A variable that grows at 7 percent a year doubles in 10 years
- A variable that grows at 2 percent a year doubles in 35 years
- A variable that grows at 1 percent a year doubles in 70 years
How Potential GDP Grows
Economic growths occurs when Real GDP increases
But a one-shot increase in Real GDP or a recovery from recession is not economic
growth
Economic growth is the sustained, year-on-year increase in potential GDP
What Determines Potential GDP?
find more resources at oneclass.com
find more resources at oneclass.com

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Gowtham Kirupakaran
February 8th, 2017
ECN204-011
Potential GDP is the quantity of Real GDP produced when the quantity of labour
employed is the full-employment
To determine potential GDP we use a model with two components
- An aggregate production function
- An aggregate labour market
Aggregate Production Function
Tells us how real GDP changes as the quantity of labour changes when all other
influences on production remain the same
An increase in labour increase real GDP (positive slope)
Increasing at a decreasing rate (diminishing marginal returns)
Adding labour increases but at a slower rate
As L goes up faster and faster, Y goes up slower and slower
Aggregate Labour Market
The demand for labour shows the quantity of labour demanded and the real wage rate
Real wage rate is the money rate divided by the price level
The supply of labour shows the quantity of labour supplied and the real wage rate
The labour market is in equilibrium at the real wage rate at which the quantity of labour
demanded = the quantity of labour supplied
Labour Demand (negative slope) is inversely related
- real wages goes up and labour demand falls (vice versa) employment will fall which
means that less goods being produced and bought so Y decreases (vice versa)
Labour Supply us working (positive slope) is not
- real wages goes up and labour supply goes up (vice versa)
- employment will rise which means that more goods are produced and bought
causing Y increases (vice versa0
Potential GDP
The quantity of Real GDP produced when the economy is at full employment is potential
GDP
Input is labour and output is for Real GDP
What Makes Potential GDP Grow?
We begin by dividing Real GDP growth into the forces that increase:
- Growth in the supply of labour
- Growth in labour productivity
find more resources at oneclass.com
find more resources at oneclass.com