Chapter 10 - Economic Growth, the Financial System, and Business Cycles

Long-run economic growth is

the process by which productivity increases the average standard of living

Business cycle

the alternating periods of economic expansion and economic recession

Real GDP per capita

the amount of production in the economy, per person, adjusted for changes in the price level

Economic prosperity and health go hand in hand

richer nations can devote more resources to improving the health of their citizens, and healthier citizens are more productive

Another important measure of our improvement is

the increase in our lifespans

A good measure of economic prosperity is

the amount of time we can spend on leisure

As our lifespans grow

we can spend more time on leisure; and also as we grow more productive, we can devote less time to work, and hence more leisure

Calculate the growth rate (percentage change). In 2021 Real GDP was $21.4 trillion and in 2022 Real GDP was $21.8 trillion.

( ($21.8 trillion - $21.4 trillion) ÷ ($21.4 trillion) ) × 100 = 1.9% Remember ( ( current year - base year) ÷ base year) × 100 = percentage change

Calculate the growth rate over a few years. In 2020: real GDP growth -2.2%. In 2021: real GDP growth 5.8%. In 2022: real GDP growth 1.9%. So, the average annual growth rate over this three year period was?

(-2.2% + 5.8% + 1.9%) ÷ 3 = 1.8%

(Growth rates over longer periods) Rule of 70 can help us determine how long it will take for an economic variable to double:

Number of years to double = 70 ÷ growth rate

Apply Rule of 70. If the growth rate is 5 percent, the variable will double in

70 ÷ 5 = 14 years

Increases in real GDP per capita rely on increases in

labor productivity

What is labor productivity?

The quantity of goods and services that can be produced by one worker or by one hour of work

Why can the average American consume more than nine times as many good and services now than in 1900?

Because the average American produces more than nine times as many goods and services in an hour now than in 1900.

Use the graph to help determine which one of the following statements is​ true:

The average American in the year 2020 could buy more than eight times as many goods and services as the average American in the year 1900.

What are factors that affect labor productivity growth?

Increases in capital per hour worked, technological change, and property rights

Property rights

A market system can't function unless right to private property are secure. Governments can aid growth by establishing independent court systems to enforce contracts between private individuals.

Technological change

improvements in capital or methods to combine inputs into outputs (new tech) allowing workers to produce more. The role of entrepreneurs here is critical in pioneering new ways to being together the factors or production to produce better, lower cost products

Increases in capital per hour worked

capital is physical assets and intellectual property that are used to produce other goods and services. The more capital a worker has the more productive they'll be.

Potential GDP is

the level of real GDP attained when all firms are operating at capacity. Capacity refers to "normal" hours and sized workforce

What happens when the labor force expands, a nation acquires more capital stock or when new technologies are created?

the Potential GDP rises

Retained earnings

reinvesting profits back into the firm

Firms can finance some of their own expansion through

retained earnings, often firms want to obtain more funds for expansion than are available in this way

How do firms obtain retained earnings?

via the financial system

What is the financial system?

the system of financial markets and financial intermediaries through which firms acquire funds from households

Financial markets are

markets where financial securities, such as stocks and bonds, are bought and sold

What is Financial security

a document (sometimes electronic) stating the terms under which funds pass from the buyer of the security to the seller

What is a stock?

a financial security representing partial ownership of a firm

What is a Bond?

a financial security promising to repay a fixed amount of funds…essentially a loan from a household to a firm

Financial intermediaries are

firms, such as banks, mutual funds, pension funds, and insurance companies, that borrow funds from savers and lend them to borrowers.

Risk sharing

by allowing investors to spread their money over many different assets, investors can reduce their risk while maintaining a high expected return on their investment

Liquidity

the financial system allows savers to quickly convert their investments into cash

Information

This aggregation of information makes funds flow to the right firms: the prices of financial securities represent the beliefs of other investors and financial intermediaries about the future revenue stream from holding those securities.

Recall that we can express the GDP of a nation (Y) as

the sum of consumption C, investment (I), government purchases (G), and net exports (NX)

The equation for the GDP of a nation is

Y = C + I + G + NX

The equation for a closed economy is

Y = C + I + G

The expression for investment spending by businesses is

I = Y - C - G

Savings is composed of

private savings (by households, S-private) and public savings (S-public)

Private saving or S-Private is

household income that is not spent

Private saving is equal to

Y - C - T

Private savings with transfers is equal to

Y + TR - C - T

Labor productivity is

The quantity of goods and services that can be produced by one worker or by one hour of work.

Increases in real GDP per capita depend on

increases in labor productivity

Labor productivity is affected by two​ factors:

Capital per hour​ worked and Technological​ change

Technological change refers to

the processes a firm uses to turn inputs into outputs of goods and services. Technological change is the increase in the quantity of output that firms can produce given a quantity of inputs.

Capital Hours Worked refers to

the manufactured goods that are used to produce other goods and​ services, such as​ computers, factory​ buildings, machine​ tools, and warehouses.

Which of the following does NOT lead to long-run economic growth?

increase in average wages

Which of the following do lead to economic growth?

Increase in the capital stock, technological change, improved labor productivity

Long-run economic growth is

the process by which rising productivity increases the average standard of living

Potential GDP

increases over time as technological change occurs AND increases over time as the labor force grows.

A firm's capacity is measured by

its production during normal business hours. This changes as the economy experiences long-run growth.

Math Practice: Real GDP in 2006 = $11,567 and Real GDP in 2007 = $11,916. Assuming the population is constant over the two years, how many years will it take for real GDP per capita to double? (Rule of 70)

First find percentage change: ((11,916 - 11,567)÷11,567) × 100 = 3.0172% Now apply the rule of 70: 70 ÷ 3 = 23.3333….23.3 Years to double

Which of the following statements about real and potential GDP is true?

potential GDP increases every year (as technological change happens and labor force grows)

What other key services do financial intermediaries provide to savers and lenders?

allows savers to spread their money through investments, provides easy method of exchanging money or financial security, collect and communicate info about borrowers to savers

Market for loanable funds is

the interaction of borrowers and lenders that determines market interest rate and quantity of loanable funds exchanged

The demand for loanable funds is determined by the

willingness of firms to borrow money for investment spending

The supply of loanable funds is determined by the

willingness of households to save and the extent of government saving or dissaving.

Evaluate the statement: "Saving money is not lending. How can it​ be? When I save my​ money, I put it in a bank. I​ don't loan it out to someone​ else." The statement is

incorrect. The supply of loanable funds is determined by household saving

During expansions

inflation and employment increase.

During recessions

inflation and employment decrease.

​Expansion: During a business cycle​

spending by firms and households is strong. As sales​ increase, firms increase production and hire more workers. With spending​ strong, firms find it easier to raise prices.

Recession: A recession will often begin with

A decline in spending by firms on capital goods or by households on consumer durables leads to lower sales. As sales fall, firms cut production and lay off workers, causing rising unemployment and lower incomes. This further reduces spending, and during a recession, firms struggle to sell goods and are unlikely to raise prices.

What is the general relationship between the business cycle and unemployment and​ inflation?

During an​ expansion, unemployment falls and inflation increases.

During the expansion phase of the business​ cycle, production,​ employment, and income

increase

During the recession phase of the business​ cycle, production,​ employment, and income

decrease

Increasing importance of services and the declining importance of​ goods:

During a​ recession, households reduce purchases of durable goods more than they reduce purchases of​ services, such as medical care.

Unemployment insurance and government transfer​ programs are:

programs that make it possible for workers who lose their jobs during recessions to have higher incomes. As a​ result, they spend more than they would otherwise.

Government​ policies:​

Arguably, policies, such as monetary policy​ (conducted by the Federal Reserve​ Bank) and fiscal policy​ (conducted by the federal​ government), have played a key role in stabilizing the economy.

Which of the following​ contribute(s) to shorter​ recessions, longer​ expansions, and less severe fluctuations in real​ GDP?

a service based economy, monetary policy, and social security benefits, fiscal policy,

Panel​ (a) shows an idealized business cycle. Panel​ (b) shows an actual business cycle by plotting fluctuations in real GDP during the period from 2006 to 2020. Use the graphs to help determine which one of the following statements is NOT​ true:

Inconsistent movements in real GDP around the business cycle peak can mean that the beginning and ending of a recession are​ clear-cut.

Use the graph to help determine which one of the following statements regarding fluctuations in real GDP is​ true:

In the first half of the twentieth​ century, real GDP had much more severe swings than in the second half of the twentieth century.

Use the graph to help determine which one of the following statements regarding inflation and business cycles is true. Note: The points on the figure represent the annual inflation rate measured by the change in the consumer price index​ (CPI) for the year ending in the indicated month.

Toward the end of the​ 1991-2001 expansion, the inflation rate began to rise.

Use the graph to help determine which one of the following statements regarding unemployment and business cycles is true.

The unemployment rate usually continues to rise even after the recession has ended.

The computation of the average annual growth rate of real GDP

is more complex when examining data for a long period of time than when examining data for only a few years.

What is the best use of the rule of 70 among those listed​ below?

to judge how rapidly real GDP per capita is growing over long time periods

Which of the following changes does not cause an increase in the quantity of goods and services that can be produced by one​ worker, or in one hour of​ work?

an increase in the number of workers

Which of the following changes will ensure that an economy experiences sustained economic​ growth?

technological change

Potential GDP is

sometimes​ greater, sometimes​ less, and sometimes equal to actual real GDP.

Which of the following are financial securities that represent promises to repay a fixed amount of​ funds?

bonds

Which of the following is NOT a service that the financial system provides for savers and​ borrowers?

guaranteeing savers high rates of return

Which of the following equals the amount of public​ saving?

Government tax revenue minus the sum of government purchases and transfer payments to households.

A government that collects more in taxes than it spends experiences

a budget surplus.

In determining whether to borrow​ funds, firms compare the rate of return they expect to make on an investment with

the interest rate they must pay to borrow the necessary funds.

Which of the following factors determines the supply of loanable​ funds?

the willingness of households and governments to save

Holding all else​ constant, a federal government budget deficit will

decrease the supply of loanable funds and increase the equilibrium real interest rate.

From a trough to a​ peak, the economy goes through

the expansionary phase of the business cycle.

​Typically, when will the National Bureau of Economic Research​ (NBER) announce that the economy is in a​ recession?

a year or more after the recession has begun

As the economy nears the end of an​ expansion, which of the following typically​ occurs?

Interest rates are usually rising, the profits of firms will be falling, and wages are usually rising faster than prices

Purchases of which types of goods are business cycles most likely to​ affect?

durable goods

Recessions cause the inflation rate to​ _________, and the unemployment rate to​ _________.

​decrease; increase

Which of the following is NOT a reason that the economy is considered to have been more stable in the 1950-2007 period than in other​ periods?

continually falling oil prices

During the last half of the twentieth​ century, the U.S. economy experienced

long​ expansions, interrupted by relatively short recessions.

​Long-run growth in GDP is determined by

​capital, labor​ productivity, and technology.

Technological progress is affected by

entrepreneurship, private property rights, new software developments, investment capital

In a closed​ economy, the values for​ GDP, consumption​ spending, investment​ spending, transfer​ payments, and taxes are as​ follows: Y​ = $11 trillion, C​ = $8 trillion, I​ = ​$2 trillion, TR​ = $1 trillion, T​ = ​$2 trillion. Using the information​ above, what is the value of private saving and public​ saving?

Private saving equals ​$2 trillion and public saving equals ​$0 trillion.