Exam 2 Flashcards
Macroeconomics
concerned with both long-run economic growth and sort-run business cycles
World bank 2010
1.22 billion people live on less than $1.25 a day in 2010
World bank 1980
2 billion people live on less than $1.25 a day in 1980
World bank other
2.4 billion people live on $2 a day
US poverty for a family of 4
$23050 for a family of four
US poverty per person per year
$5762 per per person per year
US poverty per person per day
$15.79 per person per day
US poverty vs world bank
1200% of world bank standard
growth rate
small differences in the growth rate lead to large standard of living differences in a single generation
rule of 70
70 / growth rate
time required for income to double
Economic growth
- an increase in the amount of goods that an economy can sustainable produce
- ignoring short run fluctuations in GDP growth and unemployment
- focus on the determinants of potential output
how to represent economic growth
we can represent potential output using a production function
Y/L
output per worker
K/L
capital per worker
capital
the stock of machines, structures, and equipment used to produce goods
L
labor
curve
the curve represents how much (Y/L) can be produced using certain amounts of (K/L)
increase in (K/L)
- always results in higher Y/L
- results in on the margin a smaller increase in Y/L
- the change in K/L is the same but the change in Y/L gets smaller
The Prod Function
- concave
- diminishing returns
- the marginal product of capital decreases as K/L increases
marginal product of capital
the increases in Y/L from adding one or more unit of K/L
(why assume diminishing returns?)
as K/L increases…
- capital is spread more thinly across available workers
- each additional unit of K/L gets put towards the most productive use available. subsequent units are put towards marginally less productive uses
investments
- additions to the capital stock (K)
- given diminishing returns investments are necessary for growth but not sufficient
- are made from resources the consumption of which is foregone (sacrificed)
- come from savings
production function shifts
- upward over time
why? - technological change
- improvements in institutional quality
technology
- the knowledge of how to combine labor (L) and capital (K) to produce output (Y)
- ideas and usable knowledge
Institutions
- the humanly devised constraints on how to combine labor and capital to produce output
- can be formal, informal, or a mix of both
- constraints on how existing technologies are put to use
Douglas North
- Won the Nobel Prize
- “institutions are the rules of the game in society”
examples of institutions
- legal codes
- constitution
- religions
- norms of behavior
effective institutions
facilitate exchange by decreasing transaction costs
formal institutions
one written down
legal codes, constitution, religion
informal institutions
one not written down
norms of behavior, religions
transaction costs
the time, money, and effort used up in making mutually beneficial exchanges happen
institutions that tend to promote economic growth
- well defined and enforced property rights
- stable, low levels of regulation
- honest (transparent) government
- political stability
- dependable legal system ( presence of the “rule of laws”)
when institutions promote economic growth..
- individuals internalize the cost of their actions
- individuals can effectively plan over significant time horizons
- “rules of the game” are strong and stable (persistent)
Nonrivalry good
one persons use of a good does not hinder another persons use of the good
- ex. a joke: you can think the same thing at the same time and it wont effect the other person
rivalry good
only one person can enjoy it at a given time
- ex. coffee
Nonrivalry of ideas
- makes policy regarding technological progress tricky
ex ante
before the fact
ex post
after the fact
ex ante Nonrivalry ideas
- people need incetives to innovate
- they need to expect to profit from their ideas
- they must be able to exclude others from using their ideas
ex post Nonrivalry ideas
- once an idea exists, the marginal cost of someone else benefiting from using it is (close to) zero
- you should not exclude others from using it
Time consistency problem (rich and poor countries)
ex. patents
- for rich countries: (with relatively good institutions) fostering technological progress is the key to economic growth
- for poor countries: the key is getting the institutions right
Time consistency problem ex ante
providing intellectual property protection provides the incentives to innovate
Time consistency problem ex post
allowing others to use existing ideas when the marginal cost is close to zero seems to make sense
poor countries
public good characteristics: nonrival and nonexcludable
- a lot of nearly “free lunches” avaliable to developing economies. How to best make use of existing technologies
to make use of new technologies
one needs the tools, equipment and structures in which they are embodied or with which they are produced
positive time preference
- people prefer consumption now over consumption later
- they need to be compensated for saving (interest)
financial markets
- markets where the demand for new capital (investment) meets the supply of saving
- deal in loans that are paid back over time
supply of savings
- (supply of credit)
1. time preference
2. desire for smooth consumption
3. the interest rate
demand to invest
- (looking to borrow)
1. productivity of its investment opportunities
2. the interest rate
what happens when firms perceive their investments to be more productive
- they anticipate higher demand for their goods
or - technological improvements
asymmetric information problems
- occurs when one party to a transaction has insufficient information regarding the other party
- online ratings helps alleviate information asymmetry problems
Savers (lenders) may have insufficient information about…
- the profitability of investments
- what borrowers do with the funds
- the outcome of the investments
Asymmetric Information Problems
- adverse selection problems
- moral hazard
adverse selection problems
when bad credit risks (someone you do not want to lend to) are the ones what are most likely to seek out loans
adverse selection problems occurs if borrowers..
- do not plan on repaying in the first place
- do not understand the burden of repayment
