Econ 1202 1st Edition Lecture 15Outline of Last LectureI. First Take: Adam SmithII. Labor ProductivityIII. Smithian GrowthIV. Second Take: Schumpeterian GrowthV. Modern Growth TheoriesVI. Institutional FrameworkVII. InstitutionsVIII. Sustaining Increases in Labor Productivity: The Short Hand FormulationIX. Per Worker Production FunctionX. Investment and the Financial MarketsXI. Investment and SavingOutline of Current LectureI. Investment-Savings (I=S) LinkII. Market for Loanable Funds: Mirror to Primary Bond MarketIII. Impact of Higher interest RatesIV. Aggregate Demand and Aggregate Supply ModelV. Basic IdeaVI. What does the Model look like?VII. Aggregate DemandVIII. Real Wealth EffectCurrent LectureEconomic Growth (continued)I. Investment-Savings (I=S) Linka. Assume a closed economyi. Y=C+I+Gii. I=Y-C-Giii. Savings=Private Savings (PrS)+Public Savings (PuS)1. PrS=Y-T-C2. PuS=T-G3. I=Pus+PrSII. Market for Loanable Funds: Mirror to Primary Bond Marketa. We have seen the Loanable Funds Market before because it incorporates the Primary Bond Marketb. Demand for Loanable Funds is almost equal to the Supply of Bondsc. Supply of Loanable Funds is almost equal to the Demand for Bondsd. Increase in the Demand for Loanable Funds:i. Suppose that technological change occurs, so that investment becomes more profitable for firmsii. This will increase the demand for loanable funds and the real interest rate will rise1. Increase in the supply of bonds makes the price of bonds fall while interest rates risee. Crowding Out in the Market for Loanable Funds:i. Suppose the government runs a budget deficit and to fund the deficit, it sells bonds to households, decreasing the supply of funds available to firmsii. This will raise the equilibrium real interest rate and decrease the funds loaned to firms1. Crowding Out-the decline in private expenditures as a result of increases in government purchases2. Demand for private bonds is falling, price of bonds is falling, but interest rates are going upIII. Impact of Higher interest Ratesa. AD=C+I+G+NXb. G rises, but if interest rates rise then I fallsFramework of Aggregate Demand and SupplyIV. Aggregate Demand and Aggregate Supply Modela. Framework used to explain short term fluctuations in real GDP and inflationb. Framework used to examine long term economic growthV. Basic Ideaa. Real GDP and the overall price level are determined by the overall or “aggregate” demand for a nation’s goods and services in relation to a nation’s overall or “aggregate” supply of those goods and servicesb. Key Point: Even though the AD/AS model looks similar to the micro supplyand demand model, it is very differentVI. What does the Model look like?VII. Aggregate Demanda. A decrease in the price level increases the quantity of goods and services demandedb. It looks like a regular demand curve, but it isn’tc. The reason why the aggregate demand “looks” the way it does is because of the:a. Real Wealth Effectb. Interest Rate Effectc. International Trade EffectVIII. Real Wealth EffectLong-run aggregate supplyPrice LevelShort-run aggregate supplyAEquilibrium PriceAggregate demandQuantity of OutputAggregate demandQuantity of OutputPrice LevelP1P2Y1Y2a. Decrease in price level:i. Increase in the real value of moneyii. Consumers are wealthieriii. Increase in consumer spendingiv. Increase in demand for goods and servicesb. Increase in price level:i. Decrease in the real value of moneyii. Consumers are less wealthyiii. Decrease in consumer spendingiv. Decrease in demand for goods and