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Chapter 26

ECON 102 Chapter Notes - Chapter 26: Real Interest Rate, Loanable Funds, Demand Curve


Department
Economics
Course Code
ECON 102
Professor
Robert Gateman
Chapter
26

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ECON 102: Principles of Macroeconomics
Chapter 26
26.1 The Nature of Economic Growth
GDP and per capita GDP increase over time as there is growth in productivity
Economic growth: sustained, long-run increases in the level of real GDP
Benefits of Economic Growth:
There is a difference between increases in average living standards created from economic
growth and reduction in poverty that economic growth makes possible (still requires active
policy)
Rising Average Material Living Standards:
Economic growth is a powerful means of improving average material living standards
o Increases in family income can lead to changes in the pattern of consumption
o Extra money buys amenities of life and also increases saving for the future
Richer countries are able to deal with environmental impact, while poorer countries cannot
afford to
Alleviation of Poverty:
The poor do not benefit from economic growth as they are not in the work force
o Even in a growing economy redistribution policies are needed to reduce poverty
o It is easier to have redistribution policies in a rapidly growing economy
Costs of Economic Growth:
Economic growth does have some real costs
The Opportunity Cost of Economic Growth:
Growth requires heavy investment of resources in capital goods, and other areas such as
education
o These investments often have no immediate return, but rather long-term effects
Implies sacrifice in the short-term for the hope of long-term economic growth
In an economy with high investment rates, the growth rate will simultaneously increase
o Sustained growth will lead to higher consumption in the long-term but lower in the
short-term
Social Costs of Economic Growth:
Growth also accounts for existing firms expanding and producing more output
o Hiring more workers, using more equipment and intermediate goods
Existing firms may also be made obsolete by new firms
o Old products and skills are made obsolete by new ones
A high growth rate requires rapid adjustment in the labour force
o Leads to job loss and a higher educated workforce with the required skill sets
Sources of Economic Growth:
1. Growth in the labour force: may be caused by increases in the population, or increases in
the workforce

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ECON 102: Principles of Macroeconomics
2. Growth in human capital: thought of as the quality of the workforce
a. Human capital: set of skills workers acquire through formal education and on-the-job
training
3. Growth in physical capital: stock of physical capital increases through the process of
investment
a. Also includes increases in the quality of the physical capital
4. Technological improvements: brought about by innovation that introduces new products,
new ways of producing existing products and 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 which concentrates on the growth of Y*
over long periods of time, not on short-run fluctuations of output around potential
o In equilibrium, desired saving equals desired investment
Investment, Saving and Growth:
National saving: sum of private saving and public (government) saving
Desired private saving: difference between disposable income and desired consumption
With real GDP equal to Y* in the long-run, desired private saving is equal to:
o
o
o
o
In the long-run, an increase in household consumption or government purchases must
imply a reduction in national saving
National saving as a function of the real interest rate
o Vertical axis: real interest rate, horizontal axis: loanable funds ($)
o National saving (NS) curve is upward sloping, investment demand curve is downward
sloping
In the long-run, the equilibrium interest rate is determined where desired national saving
equals desired investment
At high interest rates above (I*), the amount of desired saving exceeds the amount of
desired investment, and this excess supply of loanable funds pushed down the price of
credit (the real interest rate)
At interest rates below I*, the quantity of desired investments exceeds the quantity of
desired savings, and this excess demand for loanable funds pushes up the real interest rate
An Increase in the Supply of National Saving:
Increases in NS happen from either household consumption (C) falls or government
purchases (G) fall
o Taxes also could rise, which reduces the level of consumption
o Decline in C or G means that NS rises at any real interest rate and NS shifts to the
right
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