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Chapter 7-11

Economics - Chapter 7-11 Notes.docx

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Department
Economics
Course Code
ECON 1BB3
Professor
Bridget O' Shaughnessy

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CHAPTER SEVEN – PRODUCTION AND GROWTH Productivity: Its Role and Determinants Why Productivity is so Important  Productivity: the quantity of goods/services produced form each hour of a worker’s time  Productivity is key determinant of living standards  Growth in productivity is key determinant of growth in living standards  GDP measures: o Total income earned by everyone in economy o Total expenditure on economy’s output of goods/services  Possible because economy’s income is economy’s output  Nation enjoys high standard of living if can produce large quantities of goods/services How Productivity is Determined  Physical Capital per Worker: o Physical capital: stock of equipment/structures that are used to produce goods/services o More tools allow more work to be done more quickly and accurately o Capital is an input in production process that used to be an output from the production process  Human Capital per Worker: o Human capital: knowledge and skills that workers acquire through education, training, experience o Human capital is like physical capital o Raises nation’s ability to produce goods/services o Produced factor of production (input was teachers, student time, etc.)  Natural Resources per Worker: o Natural resources: inputs into production of goods/services that are provided by nature (ex. land, rivers, mineral deposits) o Two forms: renewable and nonrenewable o Differences in natural resources responsible for differences in standards of living around world o Natural resources not necessary for economy to be highly productive  Technological Knowledge: o Technological knowledge: society’s understanding of the best ways to produce goods/services o Makes labour available to produce other goods/services o Technological knowledge is society’s understanding of how world works o Human capital is resources expended transmitting understanding to labour force Economic Growth and Public Policy The Importance of Saving and Investment  To raise future productivity: invest more current resources in production of capital  Society must sacrifice consumption of goods/services in present to enjoy higher consumption in future  Encouraging saving/investment is one way government can encourage growth and raise economy’s standard of living Diminishing Returns and the Catch-Up Effect  Diminishing returns: the benefit from an extra unit of input declines as quantity of input increases  When workers have large quantity of capital to use in producing goods/services, giving extra unit of capital increases productivity only a little  Increase in saving rate leads to higher growth only for a while  Benefits from capital become smaller over time  Long run: higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables  Easier for country to grow fast if starts out poorer  Catch-up effect: countries that start off poor tend to grow more rapidly than countries that start off rich  Poor countries: smallest amounts of capital investment raise productivity because workers do not have capital already  Rich countries: more capital make less of difference because already have capital Investment from Abroad  Foreign direct investment: capital investment owned and operated by a foreign company  Home country may buy share of ownership in corporation  Foreign portfolio investment: investment financed with foreign money but operated by domestic residents  Home country’s saving is being used to finance foreign country’s investment  GDP: income earned within country by residents and nonresidents  GNP: income earned by residents of country at home and abroad  Plant in foreign country raises income of foreign citizens (GNP) by less than it rises production in foreign country (GDP)  Foreign investment increases economy’s stock of capital leading to higher productivity and higher wages  Governments in less developed countries should encourage investment from abroad Education  Government policy can enhance standard of living by providing good schools and encouraging population to take advantage of them  Economists say education generates positive externalities  Educated person might come up with new ideas that can better everyone  Poor countries face problem of brain drain  Brain drain: emigration of highly educated workers to rich countries where they can enjoy higher standard of living  Countries that educated people leave are poorer than they would be if stayed Health and Nutrition  Healthier workers are more productive  Nation can increase productivity and raise living standards by making right investments in health  People who have bad nutrition cannot work hard  Studies show taller people are more productive (people who are malnourished will not be tall)  Poor countries suffer from malnutrition so hard to raise productivity Population Growth  Stretching Natural Resources o Book: An Essay on the Principle of Population as It Affects the Future Improvement of Society o Said ever-increasing population would strain society’s ability to provide for itself o Power of population is greater than power of earth to produce subsistence for it o Thought eliminating poverty was counterproductive o Poor could have more children putting bigger strain on production capabilities o Was wrong: mankind’s ingenuity has offset effects of larger population o New inventions allow more productivity to sustain more people  Diluting the Capital Stock Free Trade  Inward-oriented policies: policies aimed at raising productivity/living standards in a country by avoiding interaction with rest of world  Poorest countries use these  Domestic firms have protection from foreign competition  Outward-oriented policies: integrate countries into world economy  Economists think this is better for developing countries  Do not have to produce all the goods they consume  Inward-oriented policies cause living standards to fall  Countries surrounded by water find it easier to participate in international trade  Will have higher levels of income Research and Development  Technology has improved production abilities  Has improved living standards  Knowledge is a public good: once person discovers an idea it can be used freely by other people  Government encourages research and development with: o Research grants o Tax breaks to firms that engage in research and development o Patents to person/firm who invents new product Population Growth  Large population means more workers to produce goods/services  Also means more people to consume goods/services  Large population does not necessarily mean high standard of living  Stretching Natural Resources: o Malthus: ever-increasing population would continually strain society’s ability to produce for itself o Mankind was doomed to forever live in poverty o The power of the population is greater than power in the earth to produce subsistence for man o Thought that trying to stop poverty was counterproductive o Helping poor meant they could have more children putting greater strain on production o Reality: technological advances have offset growing population so standard of living is higher not lower  Diluting the Capital Stock: o Population growth means less worker will have less capital o Less capital means lower productivity and lower GDP per worker o Mostly for human capital (ex. hard to educate a large population) o More rapid population growth in poorer countries o Some countries regulate how many children family can have (ex. China can only have one child per family)  Promoting Technological Progress: o More people means more scientists, inventors, engineers to contribute to technological advances o Michael Kremer: world growth rates have increased as world population has o Larger regions experienced more rapid growth (because had more people to discover things) o Need large population for technological advances CHAPTER EIGHT – SAVING, INVESTMENT AND THE FINANCIAL SYSTEM Financial Institutions in the Canadian Economy  Financial system: group of institutions in the economy that help to match one person’s saving with another person’s investment  Financial system moves economy’s scarce resources from savers to borrowers  Savers supply money to financial system expecting to get it back with interest later  Borrowers demand money from financial system knowing they will have to pay it back with interest later  The Office of the Superintendent of Financial Institutions (OSFI): primary regulator of federally regulated banks, insurance companies, pension plans Financial Markets  Financial markets: institutions through which savers can directly provide funds to borrowers  The Bond Market: o Bond: certificate of indebtedness o Has date of maturity (time at which loan will be repaid) and interest rate o Principal: promise of interest and eventual repayment of the amount borrowed o Buyer can hold bond until maturity or sell to someone else before that o Term: length of time until bond matures o Interest rate depends on length of term o Long-term bonds: riskier so pay higher interest rates o Credit risk: probability that borrower will fail to pay some of interest or principal o High risk of default: bond buyers want higher interest rate o Provincial governments are greater credit risk than federal government o Corporate bonds pay higher interest rates than provincial bonds  The Stock Market: o Stock: a claim to partial ownership in a firm (claim to profits that firm makes) o Equity finance: sale of a stock to raise money o Debt finance: sale of bonds o Owner of stock is part-owner of corporation o Owner of bond is creditor of corporation o If business goes bankrupt bondholders are paid before stockholders o Stocks offer higher risk and potentially higher returns o Most important stock exchange in Canada: TSX o Stock exchange prices determined by supply/demand for stock in that company o Demand for stock represents people’s perception of the corporation’s future profitability o Stock index: computed as average of a group of stock prices (monitors overall level of stock prices) o Stock indexes are indicators of future economic conditions Financial Intermediaries  Financial intermediaries: financial institutions through which savers can indirectly provide funds to borrowers  Banks: o Smaller businesses would not be successful in selling bonds/stocks o Most likely to get loan from the bank o Banks take deposits from people who want to save o Use deposits to make loans to people who want to borrow o Banks create asset people can use as a medium of exchange (cheque) o Medium of exchange: item people can easily use to engage in transactions  Mutual Funds: o Mutual fund: institution that sells shares to public and uses proceeds to buy portfolio of stocks/bonds o Shareholder accepts all risk/return associated with portfolio o If value of portfolio rises shareholder benefits o If falls shareholder suffers o Primary advantage: allow people with small amounts of money to diversify (only have small amount at stake in each company) o Second advantage: give ordinary people access to skills of professional money managers Saving and Investment in the National Income Accounts Some Important Identities  Identity: equation that must be true because of the way variables in the equation are defined  Assume a closed economy  Closed economy: one that dos not interact with other economies (no international trade) GDP Total income in an Open Economy: Y = C + I + G + NX economy and total expenditure on economy’s Closed Economy: Y = C + I + G output of goods/services National Saving Total income in the S = I economy that remains after paying for OR consumption and government purchases Y – C – G = I Private Saving Amount of income that households have left after paying for taxes and Sp = Y – T – C consumption Public Saving Tax revenue government has left after paying for itSg = T – G spending  Budget surplus: excess of tax revenue over government spending (T > G)  Budget deficit: shortfall of tax revenue from government spending (T < G)  For economy as a whole: saving must equal investment The Meaning of Saving and Investment  Saving: deposit unspent income in bank or use it to buy bond/stock  Investment: purchase of new capital (ex. equipment, buildings)  S = I for economy as a whole but not for individual household/firm  Bank’s allow one person’s saving to finance another person’s investment The Market for Loanable Funds  Assume economy has only one financial market  Market for loanable funds: market in which those who want to save supply funds and those who want to borrow to invest demand funds  Only one interest rate: return to saving and cost of borrowing Supply and Demand for Loanable Funds  Supply comes from people who have extra income they want to save/lend out  Saving is source of supply of loanable funds  Demand comes from households/firms who want to borrow to make investments  Investment is source of demand for loanable funds  Interest rate is price of a loan  High interest rate makes borrowing more expensive  Quantity of loanable funds demanded falls as interest rate rises  High interest rate makes saving more attractive  Quantity of loanable funds supplied rises as interest rate rises  Demand slopes down and supply slopes up  Supply and demand for loanable funds depend on real interest rate (not nominal) Policy 1: Saving Incentives  Canadians do not save very much  If saved more, growth rate of GDP would increase and could enjoy higher standard of living  Low savings rate in Canada could be because of tax laws that discourage saving  Tax on interest income reduces future payoff from current saving  Reduces incentive for people to save  GST: o Federal Goods and Services tax (GST) o Important change to Canadian tax system o Consumption taxes encourage more saving o Income is saved not taxed  RRSP: o Registered retirement savings plans o Less of income is subject to tax o Saving is encouraged  TFSAs: o Tax-Free Savings Accounts o Income earned on savings not subject to tax o People have incentive to increase savings  Tax change would alter incentive for households to save  Would affect quantity of loanable funds supplied at each interest rate  Supply of loanable funds would shift  Demand would remain the same  Households increase saving: o Supply of loanable funds would increase o Supply curve would shift to right o Results in lower interest rates and greater investment Policy 2: Investment Incentives  Investment tax credit: Parliament passes tax reform aimed at making investment more attractive  Tax credit rewards firms that borrow/invest in new capital  Alter investment at any given interest rate  Change demand for loanable funds  Firms would have incentive to increase investment  Quantity of loanable funds demanded would be higher at any interest rate  Demand curve would move to right  Would result in higher interest rates and greater saving Policy 3: Government Budget Deficits and Surpluses  Government debt: sum of all past budget deficits and surpluses  National saving is made up of private saving and public saving  National saving is source of supply of loanable funds  Budget deficit: o Change in government budget represents change in public saving o Effects supply of loanable funds o Reduces supply of loanable funds available to finance investment by households/firms o Shifts supply curve to left o Results in increased interest rate and less investment  Crowding out: a decrease in investment that results from government borrowing  Loanable funds: flow of resources available to fund private investment  Government budget deficit reduces supply of loanable funds  Vicious circle: o Cycle that results when deficits reduce supply of loanable funds, increase interest rates, discourage investment and result in slower economic growth o Slower growth leads to lower tax revenue and higher spending on income-support programs o Result can be higher budget deficits  Budget surplus: o Opposite of budget deficits o Contributes to national saving o Increases supply of loanable funds o Reduces interest rate and stimulates investment  Virtuous circle: o Cycle that results when surpluses increase supply of loanable funds, reduce interest rates, stimulate investment and result in faster economic growth o Faster growth leads to higher tax revenue and lower spending on income-support programs o Result can be higher budget surpluses CHAPTER NINE – UNEMPLOYMENT AND ITS NATURAL RATE Identifying Unemployment How is Employment Measured?  Statistics Canada produces data on unemployment every month  Gets data from the Labour Force Survey  Places each adult (15+) in three categories: o Employed: spent some of previous week working at paid job o Unemployed: temporarily laid off or looking for a job o Not in the labour force: not in previous categories (ex. full-time student, homemaker, retiree)  Labour force: total number of workers including employed and unemployed  Labour force = Number of employed + Number of unemployed  Unemployment rate: percentage of labour force that is unemployed  Unemployment rate = (Number of unemployed/Labour force) x 100  Labour-force participation rate (LFPR): percentage of adult population that is in the labour force  LFPR = (Labour force/Adult population) x 100  Trends in Canadian population: o Women have lower rates of labour-force participation than men o People age 15-24 have higher rates of unemployment than older people o Recession in 2009 effected men more than women (more unemployed men than women) Does the Unemployment Rate Measure What We Want It To?  Hard to tell difference between person who is unemployed and person not in the labour force 1. Lying: o People who say they are unemployed but may not be trying to find a job o Might just want Employment Insurance 2. Discouraged searchers: o People who want to work but have given up looking o Might show up as out of the labour force 3. Part-time workers: o Might want to work full-time o Should be considered unemployed because are underemployed How Long Are the Unemployed without Work?  Average spell of unemployment in Canada in 2009: 15.6 weeks  Varied across the country and across different people  Could be more long-term for some people and very short-term for others Why Are There Always Some People Unemployed?  Natural rate of unemployment: rate of unemployment to which the economy tends to return in the long run  Rate in Canada: 6-8%  Cyclical unemployment: o Deviation of unemployment from the natural rate o Occurs because of short-run economic fluctuations  Frictional unemployment: takes time for workers to search for jobs that best suit their tastes/skills  Structural unemployment: number of jobs available in some labour markets is insufficient to provide a job for everyone who wants one Job Search Why Some Frictional Unemployment Is Inevitable  Frictional unemployment often a result of changes in demand for labour  Sectorial shifts: changes in composition of demand among industries/regions  Employment can rise in one industry and fall in another  Employment can rise in one region and fall in another  Unemployment is inevitable because economy is always changing Public Policy and Job Search  Policy can reduce natural rate of unemployment if can reduce time it takes workers to find new jobs  Government programs to facilitate job search: o Employment agencies o Public training programs  Supporters of government programs to help job search: o Make economy operate more efficiently by keeping people employed o Sometimes private sector cannot help people who los
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