Transcript Economics R. Glenn Hubbard, Anthony Patrick O`Brien, 2e.

Chapter 9: Economic Growth, the Financial System, and Business Cycles
What we learned in last class:
Minimum wage laws
Calculate unemployment brought about by Minimum wage laws.
Efficiency wage
Measuring inflation:
Price level: CPI vs. GDP deflator
Adjust nominal variables to real variables using CPI
Real wage vs. nominal wage
Shortcomings of CPI
Nominal interest rate vs. Real interest rate
Costs of inflation on the economy
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Growth and the
Business Cycle
at Boeing
Learning Objectives
9.1
Discuss the importance of longrun economic growth.
9.2
Discuss the role of the financial
system in facilitating long-run
economic growth.
9.3
Explain what happens during a
business cycle.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Economic Growth, the Financial System,
and Business Cycles
A key measure of the success of any economy is its
ability to increase production of goods and services
faster than the growth in population.
The only way that the living standard of the average
person can increase.
The best measure: Real GDP per capita.
Economic growth (long-run)
Business cycle (short-run) Alternating periods of
economic expansion and economic recession.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.1
Long-Run Economic Growth
Long-run economic growth The process by which rising
productivity increases the average standard of living.
FIGURE 9.1
The Growth in Real GDP
per Capita, 1900–2006
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.1
Making
the
Connection
The Connection between
Economic Prosperity and Health
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.1
Making
the
Connection
The Connection between
Economic Prosperity and Health
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.1
Long-Run Economic Growth
Calculating Growth Rates and the Rule of 70
Growth rate=
Real GDP in year t+1 - Real GDP in year t
Real GDP in year t
Number of years to double 
 100
70
Growth rate
What Determines the Rate of Long-Run Growth?
Labor productivity The quantity
of goods and services that can be
produced by one worker or by one
hour of work.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.1
Long-Run Economic Growth
What Determines the Rate of Long-Run Growth?
Increases in Capital per Hour Worked
Capital Manufactured goods that are used
to produce other goods and services.
Human capital: Accumulated knowledge
and skills workers acquire from education
and training or their life experiences
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.1
Long-Run Economic Growth
What Determines the Rate of Long-Run Growth?
Technological Change
Economic growth depends more on technological change than on
increases in capital per hour worked.
Technological change is an increase in the quantity of output firms
can produce using a given quantity of inputs.
Accumulating more inputs will NOT ensure that an economy
experiences economic growth unless technological change also
occurs.
Entrepreneurs are import in implementing technological change.
Government policies: Protecting private property, avoiding
political instability……
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.1
Solved Problem
9-1
The Role of Technological Change in Growth
Between 1960 and 1995, real GDP per capita in Singapore grew
at an average annual rate of 6.2 percent. This very rapid growth
rate results in the level of real GDP per capita doubling about
every ?? years.
In 1995, Alywn Young of the University of Chicago published an
article in which he argued that Singapore’s growth depended
more on increases in capital per hour worked, increases in the
labor force participation rate, and the transfer of workers from
agricultural to nonagricultural jobs than on technological change.
If Young’s analysis was correct, predict what was likely to happen
to Singapore’s growth rate in the years after 1995.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.1
Making
the
Connection
What Explains Rapid Economic
Growth in Botswana?
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.1
Long-Run Economic Growth
Potential Real GDP
Potential GDP The level of GDP attained when all firms are
producing at capacity.
The capacity is NOT the maximum output the firm is capable of
producing. It is the output when the firm operates on normal
hours, using normal workforce.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.1
Long-Run Economic Growth
Potential Real GDP
FIGURE 9.2
Actual and Potential Real GDP
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.2
Saving, Investment, and the Financial System
Financial system The system of
financial markets and financial
intermediaries through which firms
acquire funds from households.
An Overview of the Financial System
Financial markets Markets where financial
securities, such as stocks and bonds, are
bought and sold.
Financial intermediaries Firms, such as
banks, mutual funds, pension funds, and
insurance companies, that borrow funds from
savers and lend them to borrowers.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.2
Saving, Investment, and the Financial System
The Macroeconomics of Saving and Investment
Y = C + I + G + NX
For simplicity, we talk about a closed economy where
NX=0.
The U.S. is considered as a closed economy by economists.
Y=C+I+G
I=Y−C−G
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.2
Saving, Investment, and the Financial System
The Macroeconomics of Saving and Investment
Private saving: what households retain of their income after
purchasing goods and services (C) and paying taxes (T).
Households also receive income from government in the
form of transfer payments (TR)
Sprivate= Y + TR − C − T
Public saving: the amount of tax revenue (T) the
government retains after paying for government purchases
(G) and making transfer payments to households (TR).
Spublic= T − G − TR
Spublic=0, Balanced Budget
Spublic>0, Budget Surplus: Clinton administration.
Spublic<0, Budget Deficit: Bush administration.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.2
Saving, Investment, and the Financial System
The Macroeconomics of Saving and Investment
Total saving (S):
S=Sprivate+Spublic
or
S = (Y + TR − C − T) + (T − G − TR)
or
S=Y−C−G
So, we can conclude that the total saving must equal
to the total investment:
S=I
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
What we learned in our last class:
Economic growth: Real GDP per capita
Business cycle.
Economic prosperity and health:
life expectancy at birth
lifetime hours of paid work and of leisure
calculate growth rate and the rule of 70
What determines the long-run economic growth:
Labor productivity:
Capital per hour worked
Technological change (more important)
Entrepreneur
Government policies (Botswana)
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
What we learned in our last class:
Potential real GDP: at capacity--NORMAL level
Financial system: funds flow from households to firms
Saving and investment
Private saving and public saving
Balanced Budget, budget surplus and budget deficit
Saving=Investment
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Brief review on supply and demand curves
Law of demand:
Holding everything else constant, when the price
of a product rises, the quantity demanded of the
product decreases.
Everything else: all variables or conditions other
than price that may affect the willingness to buy.
Demand curve (demand schedule) : The
relationship between the price of a product and the
quantity of the product demanded.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Brief review on supply and demand curves
A change in demand:
A shift of the demand curve (demand, demand schedule)
A change in the relationship between the price of a product
and the quantity demanded of the product
A change in quantity demanded:
A movement along the demand curve as a result of a change
in the product’s price.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Brief review on supply and demand curves
A change in demand vs. a change in quantity demanded
A change in demand occurs if there is a change in one or
more of the variables, other than the price of the
product, that affect the willingness to buy.
When everything else is constant and only the price of the
product changes, the quantity demanded will move alone
the demand curve, BUT the demand will NOT change, the
demand curve will NOT shift!!!!!
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Brief review on supply and demand curves
Law of supply:
Holding everything else constant, when the price
of a product rises, the quantity supplied of the
product increases.
Everything else: all variables or conditions other
than price that may affect the willingness to supply.
Supply curve (supply schedule) : The relationship
between the price of a product and the quantity of
the product supplied.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Brief review on supply and demand curves
A change in supply:
A shift of the supply curve (supply, supply schedule)
A change in the relationship between the price of a product
and the quantity supplied of the product
A change in quantity supplied:
A movement along the supply curve as a result of a change
in the product’s price.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Brief review on supply and demand curves
A change in supply vs. a change in quantity supplied
A change in supply occurs if there is a change in one or more
of the variables, other than the price of the product, that
affect the willingness to supply.
When everything else is constant and only the price of the
product changes, the quantity supplied will move alone the
supply curve, BUT the supply will NOT change, the
supply curve will NOT shift!!!!!
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.2
Saving, Investment, and the Financial System
The Market for Loanable Funds
Market for loanable funds The interaction of
borrowers and lenders that determines the market interest
rate and the quantity of loanable funds exchanged.
Demand and supply in the loanable funds market:
The demand for loanable funds is determined by the
willingness of firms to borrow money.
The supply of loanable funds is determined by the
willingness of households to save and by the extent of
government saving or dissaving (negative saving).
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.2
Saving, Investment, and the Financial System
The Market for Loanable Funds
Demand and Supply in the Loanable Funds Market
FIGURE 9.3
The Market for Loanable Funds
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.2
Saving, Investment, and the Financial System
The Market for Loanable Funds
Explaining Movements in Saving, Investment,
and Interest Rates
FIGURE 9.4
An Increase in the
Demand for
Loanable Funds
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.2
Saving, Investment, and the Financial System
The Market for Loanable Funds
Explaining Movements in Saving, Investment,
and Interest Rates
Crowding out A decline
in private expenditures as
a result of an increase in
government purchases.
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.2
Saving, Investment, and the Financial System
The Market for Loanable Funds
Explaining Movements in Saving, Investment,
and Interest Rates
FIGURE 9.5
The Effect of a Budget
Deficit on the Market
for Loanable Funds
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.2
Solved Problem
9-2
How Would a Consumption Tax Affect Saving,
Investment, the Interest Rate, and Economic Growth?
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.3
The Business Cycle
Some Basic Business Cycle Definitions
FIGURE 9.6
The Business Cycle
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.3
Making
the
Connection
Who Decides if the Economy
Is in a Recession?
PEAK
TROUGH
LENGTH OF
RECESSION
July 1953
May 1954
10 months
August 1957
April 1958
8 months
April 1960
February 1961
10 months
December 1969
November 1970
11 months
November 1973
March 1975
16 months
January 1980
July 1980
July 1981
November 1982
July 1990
March 1991
8 months
March 2001
November 2001
8 months
6 months
16 months
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.3
The Business Cycle
What Happens during a Business Cycle?
The Effect of the Business Cycle on Boeing
FIGURE 9.7
The Effect of the Business Cycle on Boeing
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.3
The Business Cycle
What Happens during a Business Cycle?
The Effect of the Business Cycle on the Inflation Rate
FIGURE 9.8
The Effect of the 2001
Recession on the
Inflation Rate
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.3
The Business Cycle
What Happens during a Business Cycle?
The Effect of the Business Cycle on the Inflation Rate
FIGURE 9.9
The Impact of Recessions
on the Inflation Rate
Don’t Let This Happen to YOU!
Don’t Confuse the Price Level and the Inflation Rate
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.3
The Business Cycle
What Happens during a Business Cycle?
The Effect of the Business Cycle on the Unemployment Rate
FIGURE 9.10
How the Recession of
2001 Affected the
Unemployment Rate
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.3
The Business Cycle
What Happens during a Business Cycle?
The Effect of the Business Cycle on the Unemployment Rate
FIGURE 9.11
The Impact of Recessions
on the Unemployment Rate
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.3
The Business Cycle
What Happens during a Business Cycle?
Recessions Have Been Milder and the Economy Has Been
More Stable Since 1950
FIGURE 9.12
Fluctuations in Real GDP, 1900–2006
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.3
The Business Cycle
What Happens during a Business Cycle?
Recessions Have Been Milder and the Economy Has Been
More Stable Since 1950
Table 9-1
The Business Cycle Has
Become Milder
PERIOD
AVERAGE LENGTH
OF EXPANSIONS
AVERAGE LENGTH
OF RECESSIONS
1870-1900
26 months
26 months
1900-1950
25 months
19 months
1950-2001
61 months
9 months
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Chapter 9: Economic Growth, the Financial System, and Business Cycles
Learning Objective 9.3
The Business Cycle
Why Is the Economy More Stable?
• The increasing importance of services
and the declining importance of goods.
• The establishment of unemployment
insurance and other government
transfer programs that provide funds to
the unemployed.
• Active federal government policies to
stabilize the economy.
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