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Chapter 6

ECO100Y1 Chapter 6: Chapter 6.docx

Department
Economics
Course Code
ECO100Y5
Professor
Kalina Staub
Chapter
6

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Chapter 6: Economic Growth, the Financial System, and Business Cycles
- A successful economy is capable of increasing production of goods and services
faster then the growth in population
- Increasing production faster than population growth is the only way that the
standard of living of the average person in a country can increase
- Financial markets and financial intermediaries together make up the financial
system
-Expansion: the period of a business cycle during which total production and total
employment are increasing
-Recession: The period of a business cycle during which total production and total
employment are decreasing
-Business Cycle: Alternating periods of economic expansion and economic
recession
- Not a uniform cycle
Long Run Economic Growth
-Long- run economic growth: The process by which rising productivity increases
the average standard of living
oWe use measure of long run economic growth by increases in real GDP
per capita
Calculating Growth Rates and the Rule of 70
- Growth rate of RGDP during a particular year is equal to % change from the
previous year
- Growth rate of RGDP= new RGDP- old RGDP/old GDP x 100
- For longer periods of time we can use the average annual growth rate
- For shorter periods of time, we get approx. the same answer by averaging the
growth rate for each year
- Rule of 70
oEasy way to calculate approx. how many years it will take RGDP per
capita to double
oNumber of years to double= 70/ growth rate
What Determines the Rate of Long-Run Growth?
- Increases in RGDP per capita depend on increases in labor productivity
-Labor Productivity: the quantity of goods and services that can be produced by
one worker or by one hour of work
- 2 key factors that cause labour productivity to increase (long run):
oIncreases in Capital per Hour Worked:
workers back then
Capital: Manufactured goods that are used to produce other goods
and services
Total amount of physical capital available in a country is known as
the countries capital stock
As the capital stock per hour worked increases, worker
productivity increases
oTechnological Change

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Economic growth more dependent on technological change than
increases in capital per hour worked
- Another requirement for economic growth is that the government must provide
secure rights to private property
Potential GDP
-Potential GDP: The level of real GDP attained when all firms are producing at
capacity
- Capacity of a firm is not the maximum output the firm is capable of producing
(that would be working 24 hours 365 days a year)
- Measured by normal working hours and a normal work force
- Output gap is the percentage difference between actual GDP and potential GDP
- When output gap is negative: actual RGDP is below potential RGDP
- When output gap is positive: actual RGDP is above potential RGDP
Saving, Investment, and the Financial System
-Retained Earnings: profits that are reinvested in the firm rather than paid to the
firms owners
-Financial System: the system of financial markets and financial intermediaries
through which firms acquire funds from households
oWithout a well functioning financial system, economic growth is almost
impossible
An Overview of the Financial System
- Channels funds from savers to borrowers and channels the returns on borrowed
funds back to savers
-Financial Markets: Markets where financial securities, such as stocks and bonds,
are bought and sold
oEx. Stock market
- Stocks- financial securities that represent partial ownership of a firm
- Bonds- financial securities that represent promises to repay a fixed amount in the
future
-Financial Intermediaries: Firms such as banks, mutual funds, pension funds,
and insurance companies, that borrow funds from savers and lend them to
borrowers
- Intermediaries pay interest to savers in exchange for the use of their funds and
earn profit by lending money to borrowers and charging borrowers a higher rate
The Macroeconomics of Saving and Investment
- Total value of saving in the economy must equal the total value of investment
- GDP (Y), Consumption (C), Investment (I), Government Purchases (G), Net
Exports (NX)
- In an open economy, there is interaction with other economies
- In an closed economy, there is no trading or borrowing or lending with other
economies
- In a closed economy NX=0
- In a closed economy Y= C+I+G
oIf we rearrange this we have an expression for investment
I=Y-C-G