BC EC 132 - Ch 3: Long Run Economic Growth

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Ch 3: Long Run Economic GrowthLong Run Economic Growth is defined as a persistent increase in the economy’s po-tential for producing goods and services.- Distinction between actual production of g+s and potential for producing g+s- Position of frontier depends on the quantity and quality of a nation’s primary factors of production and available technologies (Constraints of growth)Strategies for growth: a) Increase quantity of primary factors of productionb) Improve quality of primary factors of productionc) Invent and employ new production technology- Labor (L), Capital (K), Land (T) = Primary Factors of Production - L, K are far more important to process of growth- Growth in labor force (Labor Supply) is single most important contributor to growth in nation’s total Income (Y)- Increasing Capital (K) is key to increasing economic output per personK = Plant + Equipment in private businesses and government, buildingsInvestment in physical and human capital is the key to economic growth because it simultane-ously pursues and increase in the quality of Labor (education), quantity of K which both lead to more advanced production technology- Opportunity cost of growth is that more investment comes at the expense of con-sumption. The sacrifice of consumption is too costly for poorer countries, making the growthprocess difficult to start.Ch 6: The Macro Policy Goals: Long Run Economic Growth and Full Employ-mentThree Fundamental Questions of Macroeconomics:1) What factors determine the circular flow of economic activity?2) How does the circular flow of economic activity relate to the four economic policy goals: LREG, Full Employment, Price Stability, and Stability in economic relations w/ foreign countries3) How can government effect composition of circular flow with its fiscal/monetary pol-icyLong-Run Economic Growth is the most important factor in determining the overall eco-nomic health of a nation over the long haul- Outer limit of growth in U.S. ~4% Full Employment / Low UnemploymentLabor Force = Employed (Works at least 1hr/wk) + Unemployed (Actively seeking realistic jobs)UTotal = UCyclical + USearch(Frictional) + UStructural1) Cyclical unemployment is the only category of unemployment that is highly re-sponsive to the performance of the economy and therefore to fiscal and monetary policy-Cyclical unemployment inversely related to booms/busts of economy. It exists because wages are sticky; workers prefer lay-offs and recalls rather than flexible wages. Cyclical unemployment is concentrated amongst job losers 2) Frictional Unemployment refers to the unemployment resulting from the natural frictions of the economy as new jobs are created and others destroyed. Search Unemployment (job leavers, re-entrants, and new entrants) who are searching for the best job opportunity. Natural and beneficial to laborer and employer.3) Structural Unemployment refers to severe mismatches between the unemployed and jobs that are available (Skill or geographical)UNair- Non-accelerating inflationary rate of unemployment is the sum of frictional/search unem-ployment and structural unemployment. Natural rate of unemployment is when UCyclical=0%Ch 7: The Macro Policy Goals: Price Stability and Stable Int’l Economic Rela-tionsInflation refers to a process of continuing increases in the level of prices generallyGenerally - prices of most g+s must be increasing simultaneouslyContinuing - A one time excise tax is not considered inflation- Something has to shift up the supply curve and/or the demand curve continuously over time to cause an inflation, so that prices are continuously rising.∆P/P = (CPI 2012 - CPI 2011 ) CMB - Annual rate of inflation is the increase in the cost ofCPI2011 the market basket during the yearConsumer Price Index (CPI) is based on CMB and is used to adjust for inflation in wage and pension contracts and to protect government transfer payments- Inflation does not effect the purchasing power of an individual because the circular flow is equally affected at all points- Inflationary trends are difficult to stop and may lead to hyperinflationInefficiencies and redistributions caused by inflation depends on the extent to which:a) The inflation is unbalanced- Prices of individual g+s are rising at different rates- High inflation markets tend to be in excess supply, low inflation markets tend to have excess demand.- People who favor the high inflation g+s lose purchasing power relative to othersb) The inflation is unadjusted to - Economic contracts and tax systems must be indexed to rate of inflation- Inefficiency results when not indexed to CPIc) The inflation is unexpected- The only costs to a balanced, fully adjusted to and expected inflation is shoe leather cost of managing money more closely and menu costs of having to changeprices- Debtors(borrowers) gain at the expense of creditors(lenders) when inflation is unexpectedProducer Price Index - A price index that is designed to track changes in the cost of produc-tion over time. Its three (3) components are: i) Raw Materials ii) Intermediate Materials iii) Fin-ished manufactured goodsFisher Equation - Observed interest rate on a financial security equals the real interest rate plus the expected rate of inflationiobserved is the interest rate that appears on the loan.iobserved = rreal + ∆P/PStable International Economic Relations:Imports are the ends of trade: Countries import to gain access to goods that are produced betteror more cheaply in foreign countries.Exports are the means to the end. Countries have to export in order to import. - Most counties are forced to have a zero balance of trade (Imports = Exports). - Imports > Exports means balance of trade deficit (U.S.A. has large deficit)Depreciation of a currency is when its value falls relative to other currenciesex: $1.60/£ → $1.80/£- Bad for consumers- Good for exporters and import-competing firmsAppreciation of a currency is when its value rises relative to other currenciesex: $1.60/£ → $1.40/£- Good for consumers- Bad for exporters and import-competing firms- Negative balance of trade causes currency to depreciateCh 8: The National Income and Product AccountsNational Income and National Product accounts measure the circular flow of economic activity.National Income (Value of L,K,T) = National Product (Value of G+S)Saving = Investment- The value of sales (National Product) always equals the costs of goods sold (National


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BC EC 132 - Ch 3: Long Run Economic Growth

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