week 2 Flashcards
Production and Growth
what is Real GDP per person?
a measure of living standards
it varies widely over time + from country-country
what is the growth rate?
growth in real GDP/person
ALWAYS CHECK wether its REAL or NOMINAL GDP
expressed as a %
why is the growth rate hugely important
even a small change in a country’s growth rate can make a significant difference over several generations due to compounding
what is compounding?
Compounding refers to the process by which an investment or economic output generates earnings or returns, and these earnings are reinvested or added back to the original amount, leading to exponential growth over time
– Compounding is like a snowball effect for money. You earn interest on our initial investment, then that interest gets added to your investment, so you earn even more interest next time.
what was the growth of GDP in UK in 2020 Q2 compared to Q2 in 2023
2020: -20.3%
2023: 0%
what causes long run economic growth?
2 causes
- proximate causes
- fundamental causes
fundamental causes - the “drivers” of proximate causes (such as capital
how do you calculate the inflation rate?
100 x [pt/p(t-1)-1]
if p(t-1) = 1 and p(t) = 1.2 then what is the inflation rate?
100 x ((1.2-1)/1)
= 20
What is the word definition of inflation rate?
relative change in a price index
What is CPI?
CPI measures the overall lvl of prices of goods + services bought by consumers
how to calculate CPI?
compute the cost of a fixed basket of goods in different years
CPI formula?
how to compute the inflation rate from CPI?
how does CPI differ to CPIH?
the H stands for Housing - which
- includes housing costs and council tax
- CPI doesn’t include mortgage interest payments and council tax so CPIH is arguably better measure of Cost of Living
what is the PPI?
the PPI measures the cost of a basket of g/s bought by firms
what r changes in PPI thought 2 be useful for?
predicting changes in CPI bc firms pass on casts to consumers in form of higher prices
What are personal price indices?
Personal price indices are specific measures of inflation that are tailored to the buying habits of an individual or specific group.
– can vary greatly from standard inflation measures like the CPI (Consumer Price Index), as they take into account the specific products and services that a particular individual or group tends to purchase.
why care about inflation?
[2]
- inflation directly impacts individuals purchasing power
- inflation has other important macroeconomic consequences
what are some macroeconomic consequences inflation might have?
5
- Erodes purchasing power: Persistent inflation can lead to a decrease in the purchasing power of money, meaning the same amount of money buys less over time.
- Distorts spending habits: High inflation can lead to people spending their money quickly before it loses more value, or hoarding goods due to fear of future price increases.
- Causes uncertainty: Inflation can cause economic uncertainty, leading to lower investment and savings.
- Income redistribution: Inflation can redistribute income from savers to borrowers if interest rates don’t keep up with inflation.
5.International competitiveness: If a country’s inflation is higher than its trading partners, its goods may become more expensive leading to a decrease in competitiveness.
wat r the problems w CPI?
[4]
- SUBSTIUTION BIAS - some goods’ prices rise more than others and so consumers will substitute toward goods that hv become relatively less expensive BUT the index assumes a fixed basket of goods and overstates inflation
- NEW GOODS - a gr8er variety of goods makes £ more valuable so the cost of living has delcined - but basket of goods in the index is updated only at a lag
- unmeasured quality change - need to adjust prices to reflect quality changes… when a good becomes better, its price has effectively fallen as your £ goes further
- refers to an avg individual
GDP deflator vs CPI
GDP deflator is the ratio of nominal GDP : real GDP
it reflects prices of all goods + services produced domestically
whereas CPI/PPI reflects prices of goods + services bought by consumers/firms
what does the CPI exclude?
council tax + mortgage interest payments
Can the GDP deflator and CPI inflation differ?
Yes. For ex. if oil prices rice, CPI inflation in the UK goes up by MORE than the GDP deflator as oil makes up a larger share of consumer spending than of GDP
but the two measures of inflation generally move together.
how to compare a £ today vs a £ in year T?
what is indexation?
Automatic correction by law/contract of a £ for the effects of rises in the cost of living
e.g if you have an indexed pension, the price of the pension will increase in line with inflation to match rise in living costs
There so inflation does not erode the real value of money over time
loan ________ and ______ _______ also commonly follow indexation rules to ______________.
Loan Repayments and Savings Accounts also commonly follow indexation rules to protect the value of money against inflation.
what do pensions rise in line with?
CPI
proximate vs fundamental causes?
Proximate causes are direct, immediate factors that can be easily observed and measured, like the increase in physical capital due to the expansion of factories.
BUT; fundamental causes are indirect, underlying factors that create the conditions for proximate causes to occur, like the establishment of robust trade policies that encourage foreign investment.
define productivity (proximate)
the Q of g+s produced from each unit of labour input
why is productivity SO important?
- Productivity growth is a key determinant of GDP growth ⇒ determine living standards
- Salary increases tend to follow productivity increases
4 determinants of productivity?
- physical capital
- human capital
- natural resources
- technological knowledge
what is physical capital?
stocks of equipment + structures used to produces g+s
– it stems from investments as capital is a produced factor of production
what is human capital?
knowledge and skills that workers acquire through education, training, and experience
- less tangible than physical capital
what r natural resources?
Inputs into the production of g+s provided by nature, such as land, rivers, and mineral deposits
Distinguish renewable (trees) and non-renewable (oil) natural resources
what’s technological knowledge?
Society’s understanding of the best ways to produce goods and services
what is the production function?
Y = A F(L,K,H,N)
what do each of the letters in the production function stand for?
Y = output
L = quantity of labour
K = quantity of physical capital
H = quantity of human capital
N = quantity of natural resources
A reflects the available level of technology
F () is a function that shows how inputs are combined to produce output
A function such as F is frequently referred to as a ___________ production function
neo-classical
what is a neo-classical production function?
v useful way of thinking - it captures the clear empirical relationship between these factors + economic performance
an increase in K would be what type of cause of growth?
proximate
but asking WHY K grows would be turning to the ___________ cause of that growth
fundamental
what does a society’s SOL depend on?
its ability to produce g+s
what does capital investment do?
- increases K:
save more -> higher rate of savings => invest more resources into production of capital for use in the future.
Example of policy intervention: tax incentives e.g. ISAs
- trade-off:
to invest more in capital, a society must consume less now to save more of its current income
As productivity depends on physical K, human K, natural resources + tech knowledge… can or should the gov do anything to raise these inputs?
- capital investment (K)
- human capital investments (H)
- r+d (A)
what are diminishing returns?
DR refers to a point where level of benefits gained < the amount of effort invested.
(as more investment or effort is put into something, the relative return on that investment decreases.)
As quantity of input increases, you get less benefit from an extra unit of capital
DR means… in the long run?
In the long run, higher savings rate → higher investments and capital
But the effect (holding other factor fixed) will be a smaller and smaller increase in output
draw the decreasing marginal product of capital
what does investment in human capital do?
inc. output per capita
how does DR explain the “Catch Up” effect
Countries that start off poor tend to grow more rapidly than countries that start off rich
why..?
because
Poor countries have low productivity, even small amounts of capital investment can increase workers’ productivity substantially & over the last 70 years CHINA has grown faster than JAPAN despite lower investment rates.
Investment in human capital, H, like ….?
schools, on-the-job training etc increases productivity
Government role = public education, subsidies to educating workers
DR in rich vs poor countries?
Rich Countries:
- High productivity
- Additional capital investment - small effect on productivity
Poor Countries:
- Have potential to grow faster than rich countries
what is “brain drain”?
A problem for poorer countries. The emigrationof highly trained or qualified people from a particular country.
- Recent case: Greece
- UK has benefitted a lot from this. A reason why people are worried about brexit.
Healthier (stronger, smarter) workers are…
more productive
R+D refers to…?
New ideas & technologies (wheel, spinning jenny, steam engine etc)
How can gov encourage R+D?
via publicly operated research institutes, grants… or enforce a patent system (inc. incentive to undertake r+d)
how can patents also lower innovation?
stopping others from making further developments
what is the mainstream view about productivity?
centralized investments in R&D useful (raise A); public schooling is also useful (raise H)
…
But some economists would be wary, even skeptical: “You cannot predict the next technological breakthrough”, “No one can predict what a ‘useful degree’ is”, “public schooling a potential vehicle for brainwashing”
what are other determinants of growth?
Investments from abroad (investments that don’t require the country’s own citizens to save)
specifically which foreign investments determine productivity growth? [2]
- foreign direct investment FDI
- foreign portfolio investment FPI
What causes increases in the relevant inputs (K, A, H etc.) - what are the more fundamental causes of growth?
Institutions
TO FOSTER ECONOMIC GROWTH:
1. protect property rights
2. prevent damaging instability
what are property rights?
Ability of people to exercise authority over the resources they own
Courts enforce property rights
What are the issues with institutions?
- A lack of property rights is a MAJOR problem for some countries
- Political instability another major global issue
why lack of property rights a MAJOR problem for some countries? [3]
- contracts hard to enforce
- fraud goes unpunished
- corruption
ALL of this:
- Impedes the coordinating power of markets
- Discourages domestic saving
- Discourages investment from abroad
why is political instability another major issue in the world today? [4]
Political instability is a threat to property right.
1) can cause revolutions + coups
2) revolutionary gov might confiscate capital of some businesses
3) residents have less incentive to save, invest and start new businesses
4) foreigners less incentive to invest
what is the final determinant of long-run economic growth? (NOT growth/capita)
LARGE POPULATION (larger L) - population growth
how is pop growth a determinant of LR economic growth?
MORE workers to produce G+S
-> A larger TOTAL OUTPUT of G+S
As L increases, GDP increases.
But GDP per capital (GDP/L) will not necessarily increase, in fact it may fall… why?
Population growth:
- Dilutes the capital stock → High population growthSpreads the capital stock more thinly (think of human capital and then imagine more students in a class)
– Lower productivity per worker. Lower GDP per worker
- Puts pressures on natural resources (environment).
Reducing rate of population growth therefore often seen as positive.
– Government regulation (e.g. China). Alternative: Incentives (birth control, equal opportunities, etc.)
But while rapid population growth may dilute the capital stock and wear on the environment it may also have benefits, which are..?
- It could promote technological progress
World population growth ⇒ More scientists, more inventors, more engineers. Hence a higher probability of new bright breakthrough ideas (technological progress).
At this point in time, bettering structural unemployment is not as major a concern as ______?
Participation rate and long-term sickness
