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ECON 209 (28)
Chapter 25

Economics Chapter 25 Summary.docx

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Economics (Arts)
ECON 209
Mayssun El- Attar Vilalta

Economics Chapter 25 Summary: The Difference between Short and Long Run Macroeconomics 25.1 Two Examples from Recent History Inflation and Interest Rates in Canada - Higher inflation rates = higher interest rates; the lender must charge extra interest to cover the cost of inflation rates (which erodes the dollars they will get back) thus they move in the same direction - To reduce inflation and interest rates, they must raise interest rates which will in the short run cause people to cut back on investing in new capital and purchase less big ticket items like cars and houses, but as they do this people are laid off and the country enters a temporary recession which in the long-run will lead to reduced inflation and interest rates - Long-run effects of monetary policy= money is neutral (change in money supply=no long run effect on real variables like GDP, employment and investment but affect nominal variables like price level or rate of inflation) - Short-run effects of monetary policy: money is not neutral b/c changes in money supply affect real variables Saving and Growth in Japan - Economy grew slowly b/c the Japanese saved too much - But then they later argued that these savings contributed to their remarkable economic success 40 years following 2 world war - Key to this contradiction: short-run effect of saving is different from the long-run effect - In the long run after wages and factor prices adjust to recessionary gap, greater savings lends to a larger pool of financial capital which drives down interest rates, increasing investment in capital leading to increased potential output which the economy will converge to in the long run - National income in short run is demand determined: changes in demand will lead to changes in output in that same direction—for ex: increase in demand to save = reduction in desire to spend = less total spending and reduction in national income - Long run is supply determined: sustained increase in output will be possible only if level of potential output increases which requires more factors of production or technological change A Need to Think Differently - Short-run changes in GDP= deviations of output from potential - Long-run changes in GDP= changes in level of potential output 25.2 Accounting for Changes in GDP - Value of potential GDP estimated by combining: amounts of available factors of production (like labour and capital stock); an estimate of these factors’ normal rates of utilization and an estimate of each factor’s productivity - The opening and closing of an output gap (recessionary/inflationary) is short-run - The points where potential and actual GDP meet in one year and then another where they diverge is the long-run change - When studying long-run trends in GDP economists focus on change in potential output; short run focuses on change in output gap GDP Accounting: the Basic Principle - GDP= GDP - GDP= F * GDP/F (F= stock of factors of production like labour, land and capital) - GDP= F x (F /E) x (GDP/F ) (E = Eumber of economy’s factors that are employed) - This eq’n implies we’ve added units of labour, land and capital to get number of economy’s available factors (F) - F is factor supply (total amount of factors of production economy possesses) - F EF is factor utilization rate: total supply of factors actually used or employed at any time - GDP/ F iE a simple measure of productivity: b/c it shows amount of output (GDP) per unit of input employed F E - Any change in GDP can be decomposed into a change in factor supply, a change in
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