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Economic Growth
Economic Growth, in general, means increase in economic (material) well being of average citizen.
Economic Growth
Economic Growth, in general, means increase in economic (material) well being of average citizen. It is measured as the rate of change in the real per capita income (real GDP).
Economic Growth
Economic Growth, in general, means increase in economic (material) well being of average citizen. It is measured as the rate of change in the per capita
income (GDP). That is to say, if a nation’s output of goods and services outpace population growth, average real per capita income will increase and therefore, average individual will be materially better off than before.
Economic Growth
Measuring economic growth is problematic because:
• data problem (collection frequencies, accuracy)
Economic Growth
Measuring economic growth is problematic because:
• data problem (collection frequencies, accuracy)
• distribution of the GDP
Economic Growth
Measuring economic growth is problematic because:
• data problem (collection frequencies, accuracy)
• distribution of the GDP
• better living standard? (work v. leisure)
Economic Growth
Measuring economic growth is problematic because:
• data problem (collection frequencies, accuracy)
• distribution of the GDP
• better living standard? (work v. leisure)
• Quality improvement
Short v. Long Run
Short run is defined as a period short enough that labor is the only factor that could be increased to raise output.
N
y Y=f(N)
Short v. Long RunLong run is defined as a period long enough
that we can change the capacity of production. In this case, K and L as productivity become determining factors in economic growth.
N
y Y=f(N, K) * A
Determinants of Growth
Economic growth could result from:
• increase in supply of labor• population growth
Determinants of Growth
Economic growth could result from:
• increase in supply of labor• population growth
• immigration
Determinants of Growth
Economic growth could result from:
• increase in supply of labor• population growth
• immigration
• increase in capital stock
Determinants of Growth
Economic growth could result from:
• increase in supply of labor• population growth
• immigration
• increase in capital stock
• increase in productivity
Capital and Investment
Capital is the total quantity of plant, equipment, buildings, and inventories.
Gross investment is the purchase of new capital.
Capital and Investment
Depreciation is the wearing out and scrapping of existing capital.
Net investment is gross investment minus depreciation.
Capital and Investment
Private investment is business investment plus investment in new homes and addition to inventories.
Government investment is the part of government purchases that creates social infrastructure capital.
Investment Decisions
Business investment decisions are influenced by:
1) The expected profit rate
2) The real interest rate
Investment Decisions
The Expected Profit RateThe greater the expected profit rate from new capital, the greater is the amount of investment.
Investment Decisions
The Expected Profit RateThree Major Factors Affecting the Expected Profit Rate
1) The phase of the business cycle affect expected rates of profits: In recessions sales and profits fall while during expansions
sales and profits rise. Therefore, during recessions (expansions) investment demand falls (rises)
2) Advances in technology
3) Taxes
Investment Decisions
The Real Interest Rate– The opportunity cost of funds is the real interest
rate.
Investment Decisions
The Real Interest Rate– The opportunity cost of funds is the real interest rate
– The lower the real interest rate, the greater is the amount of investment..
Investment Decisions
The Real Interest Rate– The lower the real interest rate, the greater is the amount of investment.
– The opportunity cost of funds is the real interest rate.
– If the real interest rate exceeds the expected profit rate, firms should not invest in new capital since they could earn more by loaning the funds to other firms.
Investment Decisions
Investment DemandIllustrates the relationship between investment and the real interest rate.
ID
Investment Demand
Investment (trillions of 1992 dollars)
Rea
l int
eres
t rat
e (p
erce
nt p
er y
ear)
2
4
6
8
10
12
0 0.6 1.0 1.2 1.4 1.6
a
c
b
A rise in thereal interestrate decreasesinvestment
A fall in thereal interestrate increasesinvestment
0.8
Investment Demand
Investment (trillions of 1992 dollars)
Rea
l int
eres
t rat
e (p
erce
nt p
er y
ear)
2
4
6
8
10
12
0 0.6 0.8 1.0 1.2 1.4 1.6
ID0
ID1
ID2
An increase in theexpected profit rateincreases investmentdemand
A decrease in theexpected profit ratedecreases investmentdemand
Saving Decisions
The main factors affecting household saving are:
– The real interest rateThe lower the real interest rate, the smaller is the
amount of saving and the greater is the amount of consumption.
Saving Decisions
The main factors affecting household saving are:– The real interest rate
The lower the real interest rate, the smaller is the amount of saving and the greater is the amount of consumption.
– Disposable incomeThe greater a household's disposable income the
greater is its saving.
Saving Decisions
The main factors affecting household saving are:– The real interest rate
The lower the real interest rate, the smaller is the amount of saving and the greater is the amount of consumption.
– Disposable incomeThe greater a household's disposable income the greater is its saving.
– Purchasing power of net assets• The greater the purchasing power of a
household’s net assets the less is its saving.• Net assets are assets minus debts
Saving Decisions
The main factors affecting household saving are:– The real interest rate
The lower the real interest rate, the smaller is the amount of saving and the greater is the amount of consumption.
– Disposable incomeThe greater a household's disposable income the greater is its saving.
– Purchasing power of net assets• The greater the purchasing power of a household’s net assets the less is its
saving.• Net assets are assets minus debts
– Expected future income• The lower a household’s expected future income the greater is
its saving.
Saving DecisionsSaving Supply
Illustrates the relationship between saving and the real interest rate
SS
Saving Supply
Saving (trillions of 1992 dollars)
Rea
l int
e res
t rat
e (p
erce
nt p
er y
ear)
4
6
8
10
12
0 0.8 0.9 1.0 1.1 1.2 1.3
a
b
c
A fall in the real interestrate decreasessaving
A rise in the real interestrate increasessaving
2
Saving Supply
Saving (trillions of 1992 dollars)
SS0
Rea
l int
eres
t rat
e (p
erce
nt p
er y
ear)
4
6
8
10
12
0 0.8 0.9 1.0 1.1 1.2 1.3
An increasein saving supply
A decreasein saving supply
2
SS1
SS2
Saving and Investment inthe National Economy
• Saving supply and investment demand in the world economy determine the world real interest rate.
• Saving does not necessarily equal investment in a national economy.
Saving and Investment inthe National Economy
• National investment is financed by national saving plus borrowing from the rest of the world.
• For the world as a whole, international borrowing equals international lending.
Saving and Investment inthe National Economy
• Each nation contributes to world saving and investment and so influences the world real interest rate.
• A nation’s saving and investment decisions, along with the world real interest rate, determine the amount the nation borrows from or lends to the rest of the world.
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