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ECON 201 Chapter 25 and Chapter 26

by: AnnMarie

ECON 201 Chapter 25 and Chapter 26 ECON 201

Marketplace > Louisiana Tech University > Economcs > ECON 201 > ECON 201 Chapter 25 and Chapter 26

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These notes cover lecture material and additional information from the textbook to fill in gaps that lecture material did not cover or describe in detail. There was no lecture on Friday.
Economic Principles &
Menuka Karki
Class Notes
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This 6 page Class Notes was uploaded by AnnMarie on Saturday April 23, 2016. The Class Notes belongs to ECON 201 at Louisiana Tech University taught by Menuka Karki in Spring 2016. Since its upload, it has received 9 views. For similar materials see Economic Principles & in Economcs at Louisiana Tech University.


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Date Created: 04/23/16
Chapter 25: Production and Growth Production and Growth of output in the long-run in terms of real GDP per person • Labor, capital, productivity, and how the governments could help • Government policies – saving, investment, promote research and development of technology. Economic Growth Around the World When looking at the economic growth around the would we look at the GDP per person in a given year and sometimes compare that year with another year. Productivity: Its Role and Determinants We define productivity as the amount of goods and service produce for each unit of labor input. A) How is Productivity Determined 1. Physical Capital – the stock of equipment and structures that are used to produce goods and services. 2. Human Capital – the knowledge and skills that workers acquire through education, training, and experience. 3. Natural Resources – the inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposits. 4. Technological Knowledge – society's understanding of the best ways to produce goods and services. The Production Function Economists often use a production function to describe the relationship between the quantity of inputs used in production and the quantity of output from production. For example, suppose Y is quantity of output, L is the quantity of labor, K is the quantity of physical capital, H is the quantity of human capital, N is the quantity of natural resources. Then we might write Y =AF (L, K, H, N) where F() is a function that shows how the inputs combined to produce output.Ais a variable that reflects the available production technology.As technology improves,Arises, so the economy produces more output from any given combination of inputs. Many production functions have a property called constant returns to scale. If a production function has constant returns to scale, then doubling all inputs causes the amount of output to double as well. Mathematically, we write that a production function has constant returns to scale if, for any positive number x, xY = AF (xL, xK, xH, xN). Production functions with constant returns to scale have an interesting and useful implication. To see this implication, lets set x = 1/L so that the preceding equation becomes Y/L =AF (1, K/L, H/L, N/L). Notice that Y/L is the output per worker, which is the measure of productivity. This equations says that labor productivity depends on physical capital per worker, human capital per workers, and natural resources per worker. Productivity also depends on the state of technology, as reflected by variableA. Economic Growth and Public Policy A) Saving and Investment – Opportunity Cost : Trade-Off 1. If society invests more in capital, it will consume less and save more of its current income. 2. If society invests less in capital, it will consume more and save less of its current income. B) Diminishing Returns 1. Diminishing returns is the property whereby the benefit from an extra unit of an input declines as the quantity of the input increases. 2. When economy has a low level of capital then capital produced increases but when an economy has a high level of capital then the capital produced decreases. 3. This concept that economies that are poor tend to grow more rapidly than countries that start off rich is the catch-up effect. C) Investment fromAbroad 1. Foreign Direct Investment (FDI) is capital investment that is owned and operated by a foreign country. 2. Foreign Portfolio Investment is capital investment that is financed with foreign money but is operated by a domestic resident. D) Eduction 1. Marginal productivity of worker increases. 2. Creates positive externalities. 3. Enhances the standard of living. E) Health and Nutrition 1. Healthy workers are more productive F) Property Rights and Promotion of Political Stability 1. Property Rights prevent market failure. G) Free Trade-Off 1. Trade increases the economic surplus. H) Population Growth 1. To find the GDP per person you divide the GDP by the the population 2. Dilutes capital stock 3. Capital per worker decreases when population increases Chapter 26: Saving, Investment, and the Financial System Financial System Includes all institutions in the economy that help match one person's saving with another person's investments. Financial institutions are divided into two groups 1. Financial Market – direct flow of funds ◦ Financial markets are institutions through which savers can directly provide funds to borrowers. This can be through a bond market or a stock market. ◦ Abond is a certificate of indebtedness that specifies the obligations of the borrower to the holder of the bond. The characteristics of a bond are as follows: 1. Maturity – long-term bonds pay a higher rate of interest than short-term bonds 2. Credit Risk – the more rick a bond has the higher the interest rate. 3. Tax Treatment – the interest income accrued is not taxed. 4. Debt finance is the sale of bonds to raise money. ◦ Astock is a claim to partial ownership in a firm and thus a claim to profits that the firm makes. The characteristics of a stock are as follows: 1. Astock holder is a shareholder. 2. Equity Finance is the sale of stock to raise money. 3. Stock index is an average of a group of stock prices. 2. Financial Intermediaries – indirect flow of funds ◦ Financial Intermediaries are institutions through which savers can indirectly provide funds to borrowers. ◦ There are two types of Financial Intermediaries – Banks and Mutual Funds ◦ Abank will pay interest to savers (who have saving accounts) and charge interest on borrowers.Achecking account is considered a medium of exchange.Abank will also have to hold a specific ratio of funds (reserve ratio). ◦ Amutual fund is an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds. Saving and Investment in the Natural Income Account • Some Important Identities 1. Recall that GDP is both total income in an economy and the total expenditure of an economy's output of goods and services. GDP ( denoted ad Y) is divided into four components of expenditure: consumption ( C ), investment (I), government purchases (G), and net exports (NX). We write Y = C + I + G + NX. 2. Now, assume that the economy is closed. This would mean that net exports are zero. In this case we write Y = C + I + G. 3. To find out what the identity above can tell us about financial markets, subtract C and G from both sides. We obtain Y – C – G = I 4. The left side of the equation is the total income in the economy that remains after paying for consumption and government purchases: this amount is called national saving (saving). 5. Substituting S (saving) for Y – C – G, we can write the last equation as S = I thus we can state that saving equals to investment. 6. Now, to better understand the meaning of national saving, it is helpful to manipulate the definition a bit more. Lets T denote the amount that the government collects from households in taxes minute the amount it pays back to households in form of transfer payment. We can write national saving in either two ways: S = Y – C – G or S = ( Y – T- C) +( T - G) 7. The first piece of the equation is the private saving – income that households have left after paying for taxes and consumption. The second piece of the equation is the public saving – the tax revenue that the government has left after paying for its spending. 8. If the government spends less than the tax this is called budget surplus 9. If the government spends more than the tax this is called budget deficit. Thus reduces supply of loanable funds for investment. Meaning of Saving and Investment Saving is the supply of loanable funds and investment is the demand of loanable funds. Market for Loanable Funds Market for loanable funds is the market which those who want to save supply finds and those who want to borrow to invest demand funds. If the interest rate increases then the investment demand decreases and the supply of savings increases. If the interest rate decreases then the investment demand increases and the supply of savings decreases.


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