Part 4 [The Real Economy In The Long Run] - 7. Production and growth - 8. Saving, Investment, and the financial system - 9. Unemployment and it's natural rate Flashcards
What determines Robinson Crusoe’s standard of living and why?
Because Crusoe gets to consume only what he produces, his living standard is tied to his productivity.
What is productivity?
The quantity of goods and services that a worker can produce for each hour of work.
What is the key determinant in the growth of living standards?
Growth in productivity.
What are the determinants of productivity?
Physical capital
Human capital
Natural resources
Technological knowledge
What is physical capital and why is physical capital per worker a determinant of productivity?
(Physical) capital is the stock of equipment and structures that are used to produce goods and services.
Workers are more productive if they have tools with which to work.
What is an important feature of capital as a factor of production?
It is a produced factor of production. Capital is an input into the production process that in the past was an output from the production process.
What is human capital?
The economist’s term for the knowledge and skills that workers acquire through education, training, and experience.
How is human capital similar to physical capital?
Like physical capital, human capital raises a nation’s ability to produce goods and services.
Also like physical capital, human capital is a produced factor of production.
In terms of productivity, what is an important way to view the development of human capital?
Students can be viewed as “workers” who have the important job of producing the human capital that will be used in future production.
What are natural resources?
Natural resources are inputs into production that are provided by nature, such as land, rivers, and mineral deposits.
What are the two forms of natural resources?
Renewable and Non-renewable.
Describe the role of natural resources in a nation’s standard of living.
Although differences in natural resources are responsible for some of the differences in standards of living around the world, natural resources are not necessary for an economy to be highly productive.
What is technological knowledge?
The understanding of the best ways to produce goods and services.
Describe the difference between human capital and technological knowledge.
Technological knowledge refers to society’s understanding about how the world works. Human capital refers to the resources expended transmitting this understanding to the labor force.
Describe the difference between human capital and technological knowledge in relation to productivity using the textbook metaphor.
Knowledge is the quality of society’s textbooks, whereas human capital is the amount of time that the population has devoted to reading them. Worker’s productivity depends on both the quality of textbooks they have available and the amount of time they have spent studying them.
Briefly explain why saving and investment are important for productivity.
If today the economy produces a large quantity of new capital goods, then tomorrow it will have a larger stock of capital and be able to produce more of all types of goods and services. Thus, one way to raise future productivity is to invest more current resources in the production of capital.
Why is the principle “people face trade-offs” especially important when considering the accumulation of capital?
It requires that society sacrifice consumption in the present in order to enjoy higher consumption in the future. Because resources are scarce, devoting more resources to producing capital requires devoting fewer resources to producing goods and services for current consumption.
What quickly and efficiently brings savings and investment together with minimal risk and in a transparent way, and is also a critical ingredient in the recipe for economic growth?
A well-functioning and carefully regulated financial market.
Suppose that a government pursues policies that raise the nation’s saving rate. What happens?
With the nation saving more, fewer resources are needed to make consumption goods, and more resources are available to make capital goods. As a result, the capital stock increases, leading to rising productivity and more rapid growth in GDP.
What is the property of diminishing returns?
The property whereby the benefits from an extra unit of an input declines as the quantity of the input increases.
Describe how capital accumulation is subject to diminishing returns.
When workers already have a large quantity of capital to use in producing goods and services, giving them an additional unit of capital increases their productivity only slightly.
What is the first important implication of diminishing returns on to capital accumulation.
In the long-run, the higher saving rate leads to higher level of productivity and income, but not to a higher growth in these variables.
What is the second important implication of diminishing returns on to capital accumulation.
The catch-up effect.
What is the catch-up effect?
The property whereby countries that start off poor tend to grow more rapidly than countries that start off rich.
Explain the catch-up effect.
In poor countries, workers lack even the most rudimentary tools and, as a result, have low productivity. Small amounts of capital investment would substantially raise these workers’ productivity.
Explain why rich countries don’t benefit from the catch-up effect.
Workers in rich countries have large amounts of capital with which to work, and this partly explains their high productivity. Yet with the amount of capital per worker already so high, additional capital investment has a relatively small effect on productivity.
Other than saving from domestic residents, what is the other way for a country to invest in new capital?
Investment by foreigners.
What is FDI?
Foreign domestic investment is a capital investment that is owned and operated by a foreign entity.
What is a foreign portfolio investment?
An investment that is financed with foreign money but operated by domestic residents.
What do both FDI and foreign portfolio investments have in common?
In both cases, foreigners provide the resources necessary to increase the capital stock of the domestic country. That is, foreign saving is being used to finance domestic investment.
Why do foreigners invest in another country?
Because they expect to earn a return on their investment.
How will GNP and GDP differ due to foreign investment?
When foreigners open, say, an assembly plant in another country, some of the income the plant generates accrues to people who do not live in that foreign country. As a result, foreign investment raises the income of domestic citizens (GNP) by less than it raises the production there (GDP)
Why should a poor country accept investment from abroad if much of the benefits from this investment flow back to foreign owners?
The investment increase the economy’s stock of capital, leading to higher productivity and wages.
Moreover, investment from abroad is one way for poor countries to learn the state-of-the-art technologies developed and used in richer countries.
Name the organization that tries to encourage the flow of capital to poor countries and describe how it goes about doing this.
The World Bank. This international organization obtains funds from the world’s advanced countries and uses these resources to make loans to less-developed countries so that they can invest in roads, sewer systems, schools, and other types of capital. It also offers the countries advice about how the funds might best be used.
What was one lesson learned from WWII which inspired the creation of the world bank and the IMF?
Economic distress often leads to political turmoil, international tensions, and military conflict. Thus, every country has an interest in promoting economic prosperity around the world.
What is one way (relating to human capital) that government policy can enhance the country’s standard of living?
By providing good schools and encouraging the population to take advantage of them.
How does education convey positive externalities?
An educated person might generate new ideas about how best to produce goods and services, which may enter society’s pool of knowledge, allowing everyone to use them.
What is the problem facing some poor countries in regards to human capital?
The brain drain - the emigration of many of the most highly educated workers to rich countries, where these workers can enjoy a higher standard of living.
Other than technical knowledge, describe the other type of investment in human capital which may be especially important in developing nations.
Expenditures that lead to a healthier population. Other things equal, healthier workers are more productive. Making the right investment in the health of the population is one way for a nation to increase productivity and raise living standards.
How could height be an indicator of productivity?
As nations develop economically, people eat more, and the population gets taller.
Describe the vicious circle caused by the link between health and wealth.
Poor countries are poor in part because their populations are not healthy, and their populations are not healthy in part because they are poor and cannot afford adequate health care and nutrition.
Describe the virtuous circle caused by the link between health and wealth.
Policies that lead to more rapid economic growth would naturally improve health outcomes, which in turn would further promote economic growth.
What is an important prerequisite for the price system to work?
Political stability and, more importantly, an economy-wide respect for property rights.
How do governments enforce property rights?
Trough the criminal justice system, the courts discourage direct theft.
Trough the civil justice system, the courts ensure that buyers and sellers live up to their contracts.
What is the main threat to property rights?
Political instability. When revolutions and coups are common, there is doubt about whether property rights will be respected in the future. Even the threat of revolution can act to depress a nation’s standard of living.
In what way is trade a type of technology?
When a country exports wheat and imports steel, the country benefits in the same way as if it had invented a technology for turning wheat into steel.
Describe how geography helps determine the amount of goods a nation trades.
Countries with good natural seaports find trade easier than countries without this resource. The critical importance of access to the sea helps explain why the African continent, which contains many landlocked countries, is so poor.
If most technological advance comes from private research by firms and individual inventors, why is there also a public interest in promoting these efforts?
To a large extent, knowledge is a public good: Once one person discovers an idea, the idea enters society’s pool of knowledge, and other people can freely use it.
How do federal, provincial, and territorial governments encourage advances in knowledge?
By funding research, by offering tax breaks to firms who engage in research and development, and by enforcing patents.
Why do governments enforce the patent system?
By allowing inventors to profit from their inventions - even if only temporarily - the patent system enhances the incentive for individuals and firms to engage in research.
Briefly describe the economic debate on how population size affects standards of living.
-A large population means more workers to produce goods and services.
-At the same time, however, a large population means more people consume those goods and services.
So while a large population means a larger total output of goods and services, it need not mean a higher standard of living for a typical citizen.
How did Thomas Malthus’ analysis that “the power of population in infinitely greater than the power in the earth to produce subsistence for man” prove to be inaccurate and short-sighted?
Growth in mankind’s ingenuity has offset the effects of a larger population. Pesticides, fertilizers, mechanized farm equipment, new crop varieties and other technological advances that Malthus never imagined have allowed each farmer to feed ever-greater numbers of people. Even with more mouths to feed, fewer farmers are necessary because each farmer is so productive.
Where Malthus worried about the effects of population on the use of natural resources, how do some modern theories of economic growth emphasize its effects on capital accumulation?
High population growth reduces GDP per worker because rapid growth in the number of workers forces the capital stock to be spread more thinly. In other words, when population growth is rapid, each worker is equipped with less capital. A smaller quantity of capital per worker leads to lower productivity and lower GDP per worker.
Population growth rate in some developed countries is below the rate necessary to maintain population at current levels. Policymakers in these countries are concerned that a shrinking population of working-age people will be unable to maintain economic growth rates. Why is this a concern for governments and citizens alike?
Because the result may be tax revenue that is insufficient to support a growing share of the population that is retired, hoping to collect public pensions, and expecting to be cared for in publicly funded hospitals.
How are policies that foster equal treatment of women one way for less-developed economies to reduce the rate of population growth and, perhaps, raise their standard of living?
Bearing a child, like any decision, has an opportunity cost. When the opportunity cost rises, people will choose to have smaller families. In particular, women with the opportunity to receive a good education and desirable employment tend to want fewer children than those with fewer opportunities outside the home.
Why have some economists suggested that world population growth has been an engine of technological progress and economic prosperity?
If there are more people, then there are more scientists, inventors, and engineers to contribute to technological advance, which benefits everyone. According to some economists, a large population is a prerequisite for technological advance.
What is the financial system?
The group of institutions in the economy that help to match one person’s saving with another person’s investment.
Briefly describe the motivations behind savers’ and borrows’ actions.
Savers supply their money to the financial system with the expectation that they will get it back with interest at a later date.
Borrowers demand money from the financial system with the knowledge that they will be required to pay it back with interest at a later date.
How do government regulators oversee financial institutions?
By setting the rules that guide the operation of a financial system that otherwise operates almost wholly within the private sector.
What is OFSI?
The Office of the Superintendent of Financial Institutions is an independent agency of the federal government that reports to the Department of Finance Canada.
What does OFSI do?
The OFSI is the primary regulator of federally regulated banks, insurance companies, and pension plans in Canada.
Which financial institutions are largely regulated by provincial governments?
Credit unions, caisses populaires, securities dealers, and mutual funds.
Which other other institution, other than OFSI and provincial governments, are important financial regulators?
Canada’s central bank: The Bank of Canada.
What are the two groups of financial institutions?
Financial markets and financial intermediaries.
What are financial markets?
Financial institutions through which savers can directly provide funds to borrowers.
What are the two most important financial markets?
The bond market and the stock market.
What is a bond?
A certificate of indebtedness that specifies the obligations of the borrower to the holder of the bond. An IOU.
What important information does a bond contain?
A bond identifies the time at which the loan will be repaid, called the date of maturity, and the rate of interest that will be paid periodically until the loan matures.
What options are available to a bond holder?
The buyer can hold the bond until maturity or can sell the bond at an earlier date to someone else.
Although there are many different bonds, what two characteristics are most important?
The bond’s term and its credit risk.
What is a bond’s term?
The length of time until the bond matures.
What is a perpetuity?
A bond that never matures. This bond pays interest forever, but the principal is never repaid.
What does the interest rate on a bond depend on in part?
Its term.
Why are long-term bonds are riskier (therefore requiring higher interest rates) than short-term bonds?
Because the holders of long-term bonds have to wait longer for repayment of principal. If a holder of a long-term bond needs his money earlier than the distant date of maturity, he has no choice but to sell the bond to someone else, perhaps at a reduced price. To compensate for this risk, long-term bonds usually pay higher interest rates than short-term bonds.
