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Chapter 26

Economics Chapter 26 Summary.docx

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Economics (Arts)
ECON 209
Mayssun El- Attar Vilalta

Economics Chapter 26 Summary 26.1 The Nature of Economic Growth - One of the most important reasons GDP and per capita GDP grows is growth in productivity - Economic growth: sustained, long-run increases in the level of real GDP - 3 aspects of economic growth: real GDP, real per capita GDP and productivity Benefits of Economic Growth Rising Average Material Living Standards - Economic growth raising avg. income changes whole society’s consumption patterns, shifting away from tangible goods towards services - Economic growth promotes environmental protection as poorer countries are worried about surviving whereas we have the luxury to think about the future environmental problems - Higher environmental standards= increased living standards Alleviation of Poverty - Poorest members, not in labour force cannot share the higher wages met by economic growth - Redistribution involves making someone else’s living standards lower but if there’s economic growth then when some of the increment in income is redistributed, it reduces income inequalities while all incomes rise= better/ easier for politicians to implement An Open Letter from a Supporter of the “Growth is Good” School - Growth is thought to have led to a society framed around the ordinary citizen - They argue that mass-produced goods make things available for the average person and that elitists and the wealthy want the economy to stop growing so they can maintain their exclusive rights An Open Letter from a Supporter of the “Growth is Bad” School - Believes our world is being despoiled by mindless search for ever-higher levels of material consumption at the cost of all other values - Argues about the environmental cost of our pollution and want to go back to simple times when material items were not necessary for happiness Costs of Economic Growth The Opportunity Cost of Economic Growth - More goods and services to be achieved tomorrow involve consuming less today. For economy as a whole, this sacrifice of current consumption is primary cost of growth - If you are consuming a certain percent of GDP and investing the rest, then choose to diminish the amount of GDP consumed, you immediately experience more growth rate but it must be maintained to have effects - However, the pay-off is a much larger, more rapid-growing economy Social Costs of Economic Growth - Existing firms are overtaken and made obsolete by new firms, old products and old skills are made obsolete - A high growth rate usually requires rapid adjustment in the labour force which causes upset and misery to those affected; personal cost are high but aggregately it’s beneficial to economy Sources of Economic Growth 1.) Growth in the labour force: caused by growth in population or increases in participation in the labour force 2.) Growth in Human Capital (set of skills workers acquire through formal education and on-the-job training): aka quality of the labour force 3.) Growth in Physical Capital: stock of physical capital (like factories) increases through investment; it is also included the improvements in quality of physical capital 4.) Technological improvement: brought about by innovation that introduces new products, new ways of producing existing products/ new forms of organizing economic activity 26.2 Established theories of Economic Growth Focus on the Long-Run - Theory of economic growth is a long-run theory. Concentrates on growth of potential output over long periods of time not just short-run fluctuations of output around potential - We assume all factor-price adjustment has occurred and real GDP= Y* - Savings= investment - Interest rate is endogenous variable (can be explained within model) Investment, Saving and Growth - National saving= sum of private saving and public gov’t saving - Desired private saving is the difference btwn disposable income and desired consumption - Private saving = Y*-T-C - Public saving = T- G - National Saving= Y* -T - C + T - G = Y* - C - G - Increase in household consumption or gov’t purchases = reduced national saving - Increase in interest rate = reduced household consumption = more savings - Increase in interest rate= less desired investment - Whether investment is financed by borrowing or b using firm’s retained earnings, real interest rate reflects opportunity cost of using these funds - In the long-run version of our macro model, w/ real GDP= Y*, the equilibrium interest rate is determined where desired national saving = desired investment - In disequilibrium: if desired saving exceeds desired investment, it pushes down price of credit An Increase in the Supply of National Saving - If supply of national saving increases (due to fall in household consumption or gov’t purchases or b/c T rises which reduces C) - Increase in supply of national saving leads to excess supply of loanable funds and decline in real interest rate; as interest rate falls, firms decide to undertake more investment projects and economy moves from initial equilibrium to new equilibrium; more investment = more future growth rate of potential output An Increase in Investment Demand - If firms’ demand for investment increases  I curve shifts right - Can be caused by technological improvements (increasing productivity of investment goods) or y gov’t tax incentives - Increase= rise in interest rates; so households cut back on consumption and save more - Higher saving rate (and investment) leads to higher future growth rate of potential output Investment and Growth in Industrialized Countries - There is a positive relationship between investment rates and growth rates Neoclassical Growth Theory - Aggregate production function: relationship between the total amount of each factor of production employed in the nation and the nation’s total GDP - Relationship between total amount of labour (L) and physical capital (K) employed, the quality of labour’s human capital (H), the state of technology (T) and the nation’s total level of output (GDP) - Aggregate production function is GDP= F (L,K,H)T - Tells us how much GDP will be produced for given amounts of labour, physical capital employed, given levels of human capital and a given state of technology - Labour, capital and human capital are related to GDP by the state of technology Properties of the Aggregate Production Function 1. Diminishing Marginal Returns - If labour grows but capital is constant, more people go to work using fixed quantity of capital thus the law of diminishing marginal returns is applicable - Whenever equal increases of one factor of production are combined w/ a fixed amount of another factor, the increment to total production will eventually decline 2. Constant returns to scale: situation in which output increases in proportion to change in ALL inputs as the scale of production is increased. - So if labour and capital are simultaneously increased - Total output changed by proportion of increased input; if labour & capital go up 1
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