Chapter 25 Flashcards
def. economic growth
the sustained, long-run increases in the level of real GDP
rule of 72
understand the cumulative effects of annual growth rates.
For any variable that grows at an annual rate of X percent, that variable will double in approximately 72/X years.
What are the two main benefits of economic growth
- Rising average living standards
• family that earns $48 000 today can expect an income of about
$58 500 within 10 years if it experiences a 2% annual growth.
• change the whole society’s consumption patterns.
• more environmental protection
- Addressing poverty and income inequality
• not everyone benefits directly from growth
• but redistribution is easier in a growing economy
What are the two main costs of economic growth?
- Sacrifice of Current Consumption
• growth is often encouraged by increasing investment
and saving
• which requires less consumption - Social Costs of Growth
• growth usually involves the displacement of some firms
and workers
• this process involves real transition costs
GDP accounting formula
GDP = F x (FE/F) x (GDP/FE)
- F is the factor supply.
- FE/F is the factor utilization rate.
- GDP/FE is a simple measure of productivity
**thus any change in GDP must be associated with a change in one or more of these things.
What three things affect GDP? How do they change over time?
1. Factor Supplies • Supplies of labour and capital change only gradually 2. Productivity • Productivity changes only gradually 3. Factor Utilization Rate • Fluctuates a lot in the short run • But very little in the long run
What two reasons can factor supply increase? and why/how?
- Labour: Greater immigration, an increase in birth rates or a decrease in the mortality rates. Also, an increase in the labour-force participation.
- Capital: Changes in the rate of investment generate changes in the
economy’s capital stock. But dramatic changes in the annual flow of investment generate almost imperceptible changes in the stock of
capital.
=> Long run changes
what does productivity measure?
Measures the average amount of output that is produced per unit of
input.
There can be several measures, here we use the `output per
employed factor’.
=> Long run changes
describe factor utilization
The fraction of the total supply of factors that is employed.
The factor utilization rate fluctuates in response to short-run changes in output caused by aggregate demand or aggregate supply shocks.
Over time, however, excess supply or excess demand for factors
causes an adjustment in factor prices that brings the factor of
utilization back to its ‘normal’ level.
==>These changes are not important for explaining long- run
changes in GDP
What are the four major determinants of growth?
- Growth in the labour force
- Growth in human capital, which is the set of skills workers
acquire through formal education and on-the-job training - Growth in physical capital
- Technological improvement
Different theories or economic growth emphasize different sources of growth.
In the short-run, real GDP adjusts to
determine equilibrium, in which desired saving equals desired investment.
In the model’s long-run version, ______________
real GDP is equal to Y* and the interest rate adjusts to determine equilibrium.
With real GDP equal to Y* in the long run, desired private saving is
equal to:
Private saving = Y*-T – C
Public saving is equal to the combined budget surpluses of the
federal, provincial, and municipal government. Its formula is:
Public saving = T – G
national saving formula
National saving = NS = Y*-T – C + (T – G)
NS = Y*- C – G
So for a given level of real GDP in the long run (Y*), an increase in
household consumption or government purchases implies a ________ in national saving
reduction
The supply curve for national saving and the investment demand
curve make up the economy’s market for
financial capital
Investment demand by firms is ________ related to the real interest rate.
negatively
The supply of national
saving is ________ related to the real interest rate.
positively
In the long run, with real
GDP equal to Y*, the equilibrium interest rate is determined where _____________
desired national saving equals desired investment
In the long run, an increase in the supply of national saving _______ the real interest rate and _________ more investment.
reduces interest rate, encourages more investment
The higher rate of investment leads to a _______ future growth rate of potential output.
higher
In the long run, an increase in the demand for investment ________ the real interest rate and __________ saving by households.
pushes up
encourages more
the higher rate of saving (and investment) leads to a _______ future growth rate of potential output
higher
summarize the long-run equilibrium
In long-run equilibrium, with Y=Y*,the condition NS=I determines
the equilibrium interest rate.
A shift in either the NS or the I curve a change in the equilibrium real interest rate change in the amount of the resources devoted to
investment.
An increase in the equilibrium amount of investment ==> a greater
growth rate of the capital stock ==> high future growth rate of
potential output.
Our closed-economy model predicts that a change in Canada’s investment demand or Canada’s supply of national saving leads to
a change in Canada’s equilibrium interest rate, even if the interest rates in other countries are held constant.
def. open-economy
there is a great deal of international trade in financial assets.
=> interest rates on similar assets in different countries tend to move together
describe the law of one price in a globalized financial market
Assumptions:
- Financial capital is highly mobile and can be freely traded internationally.
- There is a single type of financial capital in the world
If Canada has an excess supply for financial capital at the equilibrium
world interest rate, the extra saving can be used to acquire foreign
assets==> Canada as a whole has a capital ________ because Canadian
financial capital is flowing abroad to purchase those assets
outflow
aggregate production function
the relationship between the total amount of each factor of production employed and total GDP.
GDP = FT(L, K, H)
- L is the total amount of labour
- K is the total amount of physical capital
- H is the quality of labour’s human capital
- T is the state of technology
The notation FT indicates that the function relating L, K, and H to GDP
depends on the state of technology.
describe the key properties of the aggregate production function
The key assumptions of the Neoclassical theory are that the aggregate production function displays diminishing marginal returns when any one of the factors is increased on its own and constant returns to scale when all factors are increased together (and in the same proportion).
For simplicity, we will assume that human capital and physical capital can be combined into a single variable called capital and that technology is held constant
def. law of diminishing marginal returns
the hypothesis that if
increasing quantities of a variable factor are applied to a given
quantity of fixed factors, the marginal product of the variable factor will eventually decrease.
def. constant returns to scale
a situation in which output increases in
proportion to the change in all inputs as the scale of production is increased
Describe economic growth in the neoclassical model
- Labour-Force Growth
In the Neoclassical growth model with diminishing marginal returns, increases in population (with a fixed stock of capital) lead to increases in GDP but an eventual decline in material living standards. - Physical and Human Capital Accumulation
In the Neoclassical growth model, capital accumulation leads to improvements in material living standards, but because of the law of
diminishing returns, these improvements become smaller with each additional increment of capital. - Balanced Growth with Constant Technology
If capital and labour grow at the same rate, GDP will increase.
But in the Neoclassical growth model with constant returns to scale,
such balanced growth will not lead to increases in per capital output
and therefore will not generate improvements in material living
standards - The Importance of Technological Change
In Neoclassical growth theory, technological change is assumed to be
exogenous.
**This is an important weakness of the theory because it means that
the theory is unable to explain what is undoubtedly the most
important determinant of long-run improvements in living standards.
describe Robert Solow’s “growth accounting”
his “growth accounting” method estimates technical change as
the part of growth that is unexplained by capital accumulation
or labour-force growth.
==> the “Solow Residual”
Example: firm that adds to its stock of capital by purchasing two new
computers.
- increase in the capital stock
- Increase in the level of technology
Solow method would attribute all the change to the change in capital
stock ==> underestimates the true amount of technological change
describe endogenous technological change
Research by many scholars has established that technological change is responsive to such economic signals as prices and profits; it is endogenous to the economic system.
Growth is achieved through costly, risky, innovative activity that often occurs in response to economic signals. • Learning by Doing • Knowledge Transfer • Market Structure and Innovation • Shocks and Innovation
def. learning-by-doing
learning process at all the stages of production.
Encouraging feedback from more applied steps to the purer researchers and from users to designers
def. knowledge transfer
: diffusion of technological knowledge is not costless. Firms need research capacity to adopt new technologies, some of this knowledge is learned only through experience
def. market structure and innovation
: innovation is encourage by strong rivalry among firms and discouraged by monopoly practices.
def. shocks and innovation
shocks that would be adverse to an economy
operating with a fixed technology can provide a spur to innovation
describe increasing marginal returns
Some research suggests the possibility of increasing returns that
remain for considerable periods of time.
The sources of increasing returns fall into one of two categories:
• market-development costs
• knowledge
describe market development costs with regards to increasing marginal returns
the returns to later investment are greater than the returns to the same investment made earlier.
• Creation of new skills and attitudes in the workforce available to all subsequent
firms (externalities)
• Physical infrastructure
• The first investment will have more production problems
• Slow acceptance of new products by customers
describe increasing returns to knowledge
Shift from the economics of goods to the economics of ideas.
• Ideas can be used by one person without reducing their use by others (public
good).
• Ideas not necessarily subject to decreasing marginal returns.
• Knowledge - driven growth has unlimited potential
describe the key limits to growth
-resource exhaustion:
Technology changes continually, as do available stocks of resources.
Along with advances in technological knowledge typically comes an
increase in the economy’s resource efficiency—a reduction in the
amount of resources used to produce one unit of output.
Technology is constantly advancing, and many things that seemed
impossible a generation ago will be commonplace a generation from
now.
Such technological advance makes any absolute limits to economic
growth less likely.
-environmental degradation
