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COURSE: MACROECONOMICS
ID: IM1009
Chapter 1: Introduction
1
Contents
Session
Content
1-2-3 The System of National Accounts
4
5-6
Mankiw (VN) C10, 11,12 (ENG) 22, 23, 24
Aggregate Demand and Aggregate Supply
Mankiw (VN) C20 (ENG) 33
Unemployment and Inflation
•
7-8-9 Financial, Monetary, and Banking System
10
Readings
Macroeconomics policies
11-12 Open Macroeconomics
Mankiw (VN) C10, 15,17,22 (ENG) 28, 30, 35
Mankiw (VN) C13,16,17 (ENG) 26,29,30
Mankiw (VN) C21 (ENG) 34
Mankiw (VN) C18,19 (ENG) 31,32
13-14Presentation
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In this chapter,
look for the answers to these questions:
•
•
•
•
•
What is Gross Domestic Product (GDP)?
How is GDP related to a nation’s total income and spending?
What are the components of GDP?
How is GDP corrected for inflation?
Does GDP measure society’s well-being?
3
The circular flow of income, expenditure and output
I
C
S
C+I
Households
Firms
Y
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Government in the circular flow
I
C+I+G
C
S
G
Households
C + I + G - Te
Te
Government
Firms
B - Td
Y + B - Td
Y
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Income and Expenditure
• Gross Domestic Product (GDP) measures
total income of everyone in the economy.
• GDP also measures total expenditure on the economy’s output of g&s.
For the economy as a whole,
income equals expenditure
because every dollar a buyer spends
is a dollar of income for the seller.
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Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country
in a given period of time.
Goods are valued at their market prices, so:
§ All goods measured in the same units
(e.g., dollars in the U.S.)
§ Things that don’t have a market value are excluded,
e.g., housework you do for yourself.
7
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country
in a given period of time.
Final goods: intended for the end user
Intermediate goods: used as components
or ingredients in the production of other goods
GDP only includes final goods—they already embody
the value of the intermediate goods
used in their production.
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Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country
in a given period of time.
GDP includes tangible goods
(like DVDs, mountain bikes, beer)
and intangible services
(dry cleaning, concerts, cell phone service).
9
Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country
in a given period of time.
GDP includes currently produced goods,
not goods produced in the past.
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Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country
in a given period of time.
GDP measures the value of production that occurs within
a country’s borders, whether done by its own citizens or
by foreigners located there.
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Gross Domestic Product (GDP) Is…
…the market value of all final goods & services
produced within a country
in a given period of time.
Usually a year or a quarter (3 months)
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1. Which of the following topics are more likely to be studied by a macroeconomist than by a
microeconomist?
a. the effect of taxes on the prices of airline tickets, and the profitability of automobile-manufacturing
firms
b. the price of beef, and wage differences between genders
c. how consumers maximize utility, and how prices are established in markets for agricultural products
d. the percentage of the labor force that is out of work, and differences in average income from country
to country
2. Total income from the domestic production of final goods and services equals
a. only household expenditures on these goods and services
b. only household and business expenditures on these goods and services.
c. the expenditures on these goods and services by whoever buys them.
d. only household and government expenditures on these goods and services.
3. GDP is defined as the
a. value of all goods and services produced within a country in a given period of time.
b. value of all final goods and services produced within a country in a given period of time.
c. value of all goods and services produced by the citizens of a country, regardless of where they are
living, in a given period of time.
d. value of all final goods and services produced by the citizens of a country, regardless of where they
are living, in a given period of time.
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4. In order to include many different goods and services in an aggregate measure, GDP is computed
using, primarily,
a. market prices.
b. values of goods and services based on surveys of consumers.
c. quantities purchased by a typical urban household.
d. profits from producing goods and services.
5. Which of the following transactions adds to Vietnam GDP for 2021?
a. In 2021, Lan sells a car that she bought in 2017 to Tú for $15,000.
b. An Vietnamese professor works in Thailand during the summer of 2021 and earns the equivalent of $10,000
during that time.
c. When Minh and Yến were both single, they lived in separate apartments and each paid $150 in rent. Minh
and Yến got married in 2021 and they bought a house that, according to reliable estimates, could be rented
for $1,000 per month.
d. None of the above transactions adds to GDP for 2021.
6. Over time, people have come to rely more on market-produced goods and less on goods that they
produce for themselves. For example, busy people with high incomes, rather than cleaning their own
houses, hire people to clean their houses. By itself, this change has
a. caused GDP to fall.
b. caused GDP to rise.
c. not caused any change in GDP.
d. probably changed GDP, but in an uncertain direction; the direction of the change depends on the difference in
the quality of the cleaning that has resulted.
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The Components of GDP
• Recall: GDP is total spending.
• Four components:
• Consumption (C)
• Investment (I)
• Government Purchases (G)
• Net Exports (NX)
• These components add up to GDP (denoted Y):
Y = C + I + G + NX
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Consumption (C)
• is total spending by households on g&s.
• Note on housing costs:
• For renters,
consumption includes rent payments.
• For homeowners,
consumption includes the imputed rental value of the house, but not the
purchase price or mortgage payments.
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Investment (I)
• is total spending on goods that will be used in the future to produce
more goods.
• includes spending on
• capital equipment (e.g., machines, tools)
• structures (factories, office buildings, houses)
• inventories (goods produced but not yet sold)
Note: “Investment” does not mean
the purchase of financial assets like
stocks and bonds.
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Government Purchases (G)
• is all spending on the g&s purchased by govt
at the federal, state, and local levels.
• G excludes transfer payments, such as
Social Security or unemployment insurance benefits.
They are not purchases of g&s.
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Net Exports (NX)
• NX = exports – imports
• Exports represent foreign spending on the economy’s g&s.
• Imports are the portions of C, I, and G
that are spent on g&s produced abroad.
• Adding up all the components of GDP gives:
Y = C + I + G + NX
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U.S. GDP and Its Components, 2012
billions
% of GDP
per capita
Y
$15,596
100.0
$49,968
C
11,068
71.0
35,459
I
2,078
13.3
6,657
G
3,048
19.5
9,767
NX
–598
–3.8
–1,915
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7.
a.
b.
c.
d.
8.
Which of the following is not included in GDP of an economy?
purchases of stock and bonds
purchases of services such as visits to the doctor
purchases of capital goods such as equipment in a factory
purchases by foreigners of consumer goods produced in the United States
Consider two items that might be included in GDP: (1) the estimated rental value of owner-occupied housing
and (2) purchases of newly-constructed homes. How are these two items accounted for when GDP is
calculated?
a. Both item (1) and item (2) are included in the consumption component of GDP.
b. Item (1) is included in the consumption component of GDP, while item (2) is included in the investment component of
GDP.
c. Item (1) is included in the investment component of GDP, while item (2) is included in the consumption component of
GDP.
d. Only item (2) is included in GDP, and it is included in the investment component.
9. For a certain economy in 2005, GDP was $2,000; investment was $400; government purchases were $300;
and net exports were $70. It follows that consumption was
a. $1,370.
b. $1,330.
c. $1,230.
d. 60 percent of GDP.
10. Transfer payments are
a included in GDP because they represent income to individuals.
b. included in GDP because the income will be spent for consumption.
c. not included in GDP because taxes will have to be raised to pay for them.
d. not included in GDP because they are not payments for currently produced goods or services.
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system for classroom use.
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Macroeconomic indicators
2020
2021
2022
Q
P
Q
P
Q
P
Rice
1000
20
1200
20
1200
25
Car
500
100
500
120
600
120
Nominal GDP
Real GDP
GDP growth
Cost of Basket
CPI
Inflation (CPI)
Deflator
Inflation (deflator)
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Macroeconomic indicators
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Real versus Nominal GDP
• Inflation can distort economic variables like GDP, so we have two
versions of GDP:
• Nominal GDP
• values output using current prices
• not corrected for inflation
• Real GDP
• values output using the prices of a base year
• is corrected for inflation
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Nominal and Real GDP in the U.S.,
1965–2012
$16.000
$14.000
billions
$12.000
Real GDP
$10.000
(base year
2005)
$8.000
$6.000
Nominal
GDP
$4.000
$2.000
$0
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
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The GDP Deflator
• The GDP deflator is a measure of the overall level of prices.
• Definition:
GDP deflator = 100 x
nominal GDP
real GDP
§ One way to measure the economy’s inflation rate is
to compute the percentage increase in the GDP
deflator from one year to the next.
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The Consumer Price Index (CPI)
• measures the typical consumer’s cost of living
• the basis of cost of living adjustments (COLAs) in many contracts and
in Social Security
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How the CPI Is Calculated
1. Fix the “basket.”
The Bureau of Labor Statistics (BLS) surveys consumers to
determine what’s in the typical consumer’s “shopping basket.”
2. Find the prices.
The BLS collects data on the prices of all the goods in the basket.
3. Compute the basket’s cost.
Use the prices to compute the total cost of the basket.
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How the CPI Is Calculated
4. Choose a base year and compute the index.
The CPI in any year equals
100 x
cost of basket in current year
cost of basket in base year
5. Compute the inflation rate.
The percentage change in the CPI from the
preceding period.
Inflation
=
rate
CPI this year – CPI last year
CPI last year
x 100%
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What’s in the CPI’s Basket?
Food and bev.
7.1%
16.9%
Housing
3.2%
Apparel
Transportation
6.0%
3.6%
3.6%
3.4%
Medical care
Recreation
15.3%
Education
Communication
Other goods
and services
41.0%
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Problems with the CPI:
Substitution Bias
• Over time, some prices rise faster than others.
• Consumers substitute toward goods that become relatively cheaper,
mitigating the effects of price increases.
• The CPI misses this substitution because it uses a fixed basket of goods.
• Thus, the CPI overstates increases in the cost of living.
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Problems with the CPI:
Introduction of New Goods
• The introduction of new goods increases variety, allows consumers to
find products that more closely meet their needs.
• In effect, dollars become more valuable.
• The CPI misses this effect because it uses a fixed basket of goods.
• Thus, the CPI overstates increases in the cost of living.
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Problems with the CPI:
Unmeasured Quality Change
• Improvements in the quality of goods in the basket increase the value of
each dollar.
• The BLS tries to account for quality changes
but probably misses some, as quality is hard to measure.
• Thus, the CPI overstates increases in the cost of living.
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Two Measures of Inflation, 1960–2012
Percent change per year
15
10
5
0
-5
1960
1965
1970
1975
1980
1985
1990
GDP deflator
1995
2000
2005
2010
CPI
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Contrasting the CPI and GDP Deflator
Imported consumer goods:
• included in CPI
• excluded from GDP deflator
Capital goods:
§ excluded from CPI
§ included in GDP deflator (if
produced domestically)
The basket:
§ CPI uses fixed basket
§ GDP deflator uses basket of
currently produced goods & services
This matters if different prices are
changing by different amounts.
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GDP Does Not Value:
• the quality of the environment
• leisure time
• non-market activity, such as the child care
a parent provides his or her child at home
• an equitable distribution of income
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Then Why Do We Care About GDP?
• Having a large GDP enables a country to afford better schools, a cleaner
environment,
health care, etc.
• Many indicators of the quality of life are positively correlated with GDP.
For example…
• GAPMINDER.ORG
• https://ourworldindata.org/grapher/world-gdp-over-the-last-twomillennia?yScale=log
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11.
Suppose an economy produces only eggs and ham. In 2019, 100 dozen eggs are sold at $3 per dozen and 50 pounds
of ham sold at $4 per pound. In 2020, the base year, eggs sold at $1.50 per dozen and ham sold at $5 per pound. For
2019,
a.
nominal GDP is $400, real GDP is $500, and the GDP deflator is 80.
b.
nominal GDP is $400, real GDP is $500, and the GDP deflator is 125.
c.
nominal GDP is $500, real GDP is $400, and the GDP deflator is 80.
d.
nominal GDP is $500, real GDP is $400, and the GDP deflator is 125.
12. Rosa deposits $100 in a bank account that pays an annual interest rate of 20 percent. A year later, after Rosa has
accumulated $20 in interest, she withdraws her $120. Rosa’s purchasing power
a.
did not change if the inflation rate was 20 percent.
b.
decreased if the inflation rate was -5 percent.
c.
increased if the inflation rate was 22 percent.
d.
More than one of the above is correct.
13. Suppose the government eliminates all environmental regulations and, as a result, the production of goods and
services increases, but there is considerably more pollution. Based on this scenario, which of the following
statements is correct?
a.
GDP would definitely increase, despite the fact that GDP includes environmental quality.
b.
GDP would definitely decrease because GDP includes environmental quality.
c.
GDP would definitely increase because GDP excludes environmental quality.
d.
GDP could either increase or decrease because GDP excludes environmental quality.
14. Which of the following is a reason why the Consumer Price Index (CPI) is not calculated as a simple average of all
prices?
a.
Some goods experience large price changes and the CPI would be too variable if computed by a simple average.
b.
Goods differ in their importance in the average consumer’s budget.
c.
Some goods never experience price changes and the CPI would not be variable enough if computed as a simple average.
d.
It would be difficult to compute a price index using a simple average of all prices.
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Correcting Variables for Inflation:
Comparing Dollar Figures from Different Times
• Inflation makes it harder to compare dollar amounts from different times.
• Example: the minimum wage
• $1.15 in Dec 1964
• $7.25 in Dec 2010
• Did min wage have more purchasing power in
Dec 1964 or Dec 2010?
• To compare, use CPI to convert 1964 figure into “2010 dollars”…
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Correcting Variables for Inflation:
Comparing Dollar Figures from Different Times
Amount
in today’s =
dollars
Amount
in year T
dollars
x
Price level today
Price level in year T
• In our example,
• “year T” is 12/1964, “today” is 12/2010
• Min wage was $1.15 in year T
• CPI = 31.3 in year T, CPI = 220.3 today
The minimum wage
in 1964 was $8.09
in 2010 dollars.
220.3
$8.09 = $1.15 x
31.3
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Correcting Variables for Inflation:
Comparing Dollar Figures from Different Times
• Researchers, business analysts, and policymakers often use this technique
to convert a time series of current-dollar (nominal) figures into constantdollar (real) figures.
• They can then see how a variable has changed over time after correcting for
inflation.
• Example: the minimum wage…
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The U.S. Minimum Wage in Current Dollars
and Today’s Dollars, 1960–2012
$12,00
2012 dollars
Dollars per hour
$10,00
$8,00
$6,00
$4,00
$2,00
current dollars
$0,00
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
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Correcting Variables for Inflation:
Indexation
A dollar amount is indexed for inflation
if it is automatically corrected for inflation
by law or in a contract.
For example, the increase in the CPI automatically determines
• the COLA in many multi-year labor contracts
• adjustments in Social Security payments and federal income tax
brackets
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Correcting Variables for Inflation:
Real vs. Nominal Interest Rates
The nominal interest rate:
• the interest rate not corrected for inflation
• the rate of growth in the dollar value of a
deposit or debt
The real interest rate:
• corrected for inflation
• the rate of growth in the purchasing power of a deposit or debt
Real interest rate
= (nominal interest rate) – (inflation rate)
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Correcting Variables for Inflation:
Real vs. Nominal Interest Rates
Example:
Deposit $1,000 for one year.
Nominal interest rate is 9%.
During that year, inflation is 3.5%.
Real interest rate
= Nominal interest rate – Inflation
= 9.0% – 3.5% = 5.5%
• The purchasing power of the $1000 deposit
has grown 5.5%.
•
•
•
•
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Real and Nominal Interest Rates in the U.S.,
1950–2012
15
Interest rate
(percent per year)
10
5
0
-5
-10
1950
1955
1960
1965
1970
1975
1980
Nominal
1985
1990
1995
2000
2005
2010
Real
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15. In 1931 the price of a movie ticket was $0.25.
The consumer price index was 15.2 in 1931,
and 210 in 2008. Using 2008 prices, the real
price of a movie in 1931 was
a. $13.82.
b. $52.50.
c. $1.81.
d. $3.45.
16. Ethel purchased a bag of groceries in 1970 for
$8. She purchased the same bag of groceries
in 2006 for $25. If the price index was 38.8 in
1970 and the price index was 180 in 2006, then
what is the price of the 1970 bag of groceries
in 2006 dollars?
a. $37.11
b. $5.39
c. $25.00
d. $29.11
17. Arlo is offered a job in Des Moines, where the CPI
is 80, and a job in New York, where the CPI is 125.
Arlo's job offer in Des Moines is for $42,000. How
much does the New York job have to pay in order
for the two salaries to represent the same
purchasing power?
a. $42,000
b. $65,625
c. $68,880
d. $189,000
18. The price index in the first year is 150; in the
second year it is 160; and in the third year it is
165. Which of the following statements is correct?
a. The price level was higher in the second year than in
the first year, and it was higher in the third year than in
the second year.
b. The inflation rate was positive between the first and
second years, and it was positive between the second
and third years.
c. The inflation rate was lower between the second and
third years than it was between the first and second
years.
d. All of the above are correct.
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Economic Growth around the World
•Questions:
• Why are some countries richer than others?
• Why do some countries grow quickly while
others seem stuck in a poverty trap?
• What policies may help raise growth rates and
long-run living standards?
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Productivity
A country’s standard of living depends on its ability to produce goods and
services
• Productivity
• Quantity of goods and services
• Produced from each unit of labor input
• Productivity = Y/L (output per worker), where
• Y = real GDP = quantity of output produced
• L = quantity of labor
• Why productivity is so important
• Key determinant of living standards
• When a nation’s workers are very productive, real GDP is large and incomes are high
• Growth in productivity is the key determinant of growth in living standards
• When productivity grows rapidly, so do living standards
• An economy’s income is the economy’s output
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Determinants of Productivity
• Physical capital, K
• Stock of equipment and structures used to produce goods and services
• Physical capital per worker, K/L
• Productivity is higher when the average worker has more capital (machines,
equipment, etc.).
• An increase in K/L causes an increase in Y/L
• Human capital, H
• Knowledge and skills workers acquire through education, training, and
experience
• Human capital per worker, H/L
• Productivity is higher when the average worker has more human capital
(education, skills, etc.).
• An increase in H/L causes an increase in Y/L.
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Determinants of Productivity
• Natural resources, N
• Inputs into production that nature provides (land, rivers, and mineral deposits)
• Natural resources per worker, N/L
• Other things equal, more N allows a country to produce more Y
• An increase in N/L causes an increase in Y/L
• Technological knowledge
• Society’s understanding of the best ways to produce goods and services
• Technological progress means:
• A faster computer, a higher-definition TV, or a smaller cell phone
• Also, any advance in knowledge that boosts productivity: allows society to get more output
from its resources
• e.g., Henry Ford and the assembly line.
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Determinants of Productivity
Technological knowledge vs. Human capital
• Technological knowledge
• Refers to society’s understanding of how to produce goods and services
• Human capital
• Results from the effort people expend to acquire this knowledge
• Both are important for productivity
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The Production Function
• The production function Y = A F(L, K, H, N)
•
•
•
•
A graph or equation showing the relation between output and inputs
F( ) is a function that shows how inputs are combined to produce output
“A” is the level of technology
“A” multiplies the function F( ), so improvements in technology (increases in “A”) allow
more output (Y) to be produced from any given combination of inputs.
• The production function has the property constant returns to scale:
• Changing all inputs by the same percentage causes output to change by that percentage.
• Doubling all inputs (multiplying each by 2) causes output to double:
2Y = A F(2L, 2K, 2H, 2N)
• Increasing all inputs 10% (multiplying each by 1.1) causes output to
increase by 10%:
1.1Y = A F(1.1L, 1.1K, 1.1H, 1.1N)
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The Production Function
Y = A F(L, K, H, N)
• If we multiply each input by 1/L, then
output is multiplied by 1/L:
Y/L = A F(1, K/L, H/L, N/L)
• This equation shows that productivity (Y/L, output per worker)
depends on:
•
•
•
•
The level of technology, A
Physical capital per worker, K/L
Human capital per worker, H/L
Natural resources per worker, N,L
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Economic Growth and Public Policy
• The ways public policy can affect long-run growth in productivity and
living standards:
•
•
•
•
•
•
•
Saving and investment
Diminishing returns and the catch-up effect
Investment from abroad; Education
Health and nutrition
Property rights and political stability
Free trade; Research and development
Population growth
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19.
a.
b.
c.
d.
20.
a.
b.
c.
a.
21.
a.
b.
c.
d.
22.
a.
b.
c.
d.
The key determinant of a person’s standard of living in a country is
the amount of goods and services produced from each hour of a worker’s time.
the total amount of goods and services produced within the country.
the total amount of its physical capital.
its growth rate of real GDP.
Human capital is the
stock of equipment and structures that is used to produce goods and services.
total number of hours worked in an economy.
same thing as technological knowledge.
knowledge and skills that workers acquire through education, training, and experience.
Which of the following is considered human capital?
the comfortable chair in your dorm room where you read economics texts
the amount you get paid each week to work at the library
the things you have learned this semester
any capital goods that require a human to be present to operate
Which of the following lists contains, in this order, natural resources, human capital, and physical
capital?
For a restaurant: the land the restaurant was built on, the things the Chef learned at Cooking School, the
freezers where the chops and steaks are kept.
For a furniture company: wood, the company cafeteria, saws.
For a railroad: fuel, railroad engines, railroad tracks.
None of the above is correct.
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Saving and Investment
• Raise future productivity
• Invest more current resources in the production of capital, K
• Trade-off: since resources scarce, producing more capital requires
producing fewer consumption goods
• Reducing consumption = increasing saving
• This extra saving funds the production of investment goods (More details in
the next chapter.)
• Policies that raise saving and investment
•
•
•
•
Fewer resources are used to make consumption goods
More resources: to make capital goods
K increases, rising productivity and living standards
This faster growth is temporary, due to diminishing returns to capital:
As K rises, the extra output from an additional unit of K falls….
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The Production Function & Diminishing Returns
If workers
have little K,
giving them more
increases their
productivity a lot.
Y/L
If workers already
have a lot of K,
giving them more
increases
productivity
fairly little.
Output per worker
(productivity)
K/L
Capital per worker
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The catch-up effect: the property whereby poor countries tend to
grow more rapidly than rich ones
Y/L
Rich country’s
growth
Poor country’s
growth
Poor country
starts here
K/L
Rich country starts here
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Investment from Abroad
• Investment from abroad
• Another way for a country to invest in new capital
• Foreign direct investment
• Capital investment that is owned and operated by a foreign entity
• Foreign portfolio investment
• Investment financed with foreign money but operated by domestic residents
• Benefits from investment from abroad
•
•
•
•
•
Some benefits flow back to the foreign capital owners
Increase the economy’s stock of capital
Higher productivity and higher wages
State-of-the-art technologies developed in other countries
Especially good for poor countries that cannot generate enough saving to fund
investment projects themselves
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Education
• Education, investment in human capital
• Gap between wages of educated and uneducated workers
• In the U.S., each year of schooling raises a worker’s wage by 10%
• Opportunity cost: wages forgone
• Spending a year in school requires sacrificing
a year’s wages now to have higher wages later
• Problem for poor countries: Brain drain
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Health and Nutrition
• Health care expenditure
• Is a type of investment in human capital: healthier workers are more
productive
• In countries with significant malnourishment, raising workers’ caloric
intake raises productivity:
• 1962–1995, caloric consumption rose 44% in S. Korea, and economic
growth was spectacular.
• Nobel winner Robert Fogel: 30% of Great Britain’s growth from
1790–1980 was due to improved nutrition
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Health and Nutrition
• Vicious circle in poor countries
• Poor countries are poor because their populations are not healthy
• Populations are not healthy because they are poor and cannot afford
better healthcare and nutrition
• Virtuous circle
• Policies that lead to more rapid economic growth would naturally
improve health outcomes, which in turn would further promote
economic growth
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Property Rights and Political Stability
Markets are usually a good way to organize economic activity
• To foster economic growth
• Protect property rights (the ability of people to exercise authority over the
resources they own)
• Courts – enforce property rights
• Promote political stability
• Property rights:
• Prerequisite for the price system to work
• Lack of property rights, a major problem
• Contracts are hard to enforce
• Fraud, corruption often goes unpunished
• Firms must bribe government officials for permits
• Political instability (e.g., frequent coups)
• Creates uncertainty over whether property rights will be protected in the future
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Property Rights and Political Stability
• When people fear their capital may be stolen by
criminals/confiscated by a corrupt government
• Less investment, including from abroad, and the economy functions
less efficiently
• Result: lower living standards
• Economic stability, efficiency, and healthy growth
• Require law enforcement, effective courts, a stable constitution,
honest government officials
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Free Trade
Trade can make everyone better off
• Inward-oriented policies
• i.e. tariffs, limits on investment from abroad
• Aim to raise living standards by avoiding interaction with other
countries
• Outward-oriented policies
• i.e. elimination of restrictions on trade or foreign investment
• Promote integration with the world economy
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Free Trade
• Trade has similar effects as discovering new technologies
• Improves productivity and living standards
• Countries with inward-oriented policies
• Have generally failed to create growth.
• e.g., Argentina during the 20th century.
• Countries with outward-oriented policies
• Have often succeeded
• e.g., South Korea, Singapore, Taiwan after 1960
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Research and Development
• Technological progress
• Main reason why living standards rise over the long run
• Knowledge is a public good
• Ideas can be shared freely, increasing the productivity of many
• Policies to promote technological progress:
• Patent laws; Tax incentives or direct support for
private sector R&D
• Grants for basic research at universities
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Population Growth
Population growth may affect living standards in 3 different ways…
1.
Stretching natural resources
• 200 years ago, Malthus argued that population growth will:
• Strain society’s ability to provide for itself
• Mankind - doomed to forever live in poverty
• Since then, the world population has increased sixfold and living standards increased
• Malthus failed to account for technological progress and productivity growth
2.
Diluting the capital stock
• High population growth (higher L)
• Spread the capital stock more thinly (lower K/L)
• Lower productivity and living standards
• To combat this, many developing countries use policy to control population growth
• Government regulation (China’s one child law)
• Increased awareness of birth control
• Equal opportunities for women (Promote female literacy to raise opportunity cost of having babies)
3.
Promoting technological progress
• World population growth
• Engine for technological progress and economic prosperity
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• More people = More scientists, more inventors, more engineers = More frequent discoveries
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Are Natural Resources a Limit to Growth?
• Some argue that population growth
• Is depleting the Earth’s non-renewable resources
• And thus will limit growth in living standards.
• But technological progress often yields ways to avoid these limits:
• Hybrid cars use less gas.
• Better insulation in homes reduces the energy required to heat or cool them.
• Market economy, scarcity is reflected in market prices
• If the world were running out of natural resources, their prices would be rising
over time
• In real terms, the prices of most natural resources are stable or falling
• It appears that our ability to conserve these resources is growing more rapidly
than their supplies are dwindling
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23. Which of the following best states economists’
understanding of the facts concerning the
relationship between natural resources and
economic growth?
a. A country with no or few domestic natural resources is
destined to be poor.
b. Differences in natural resources have virtually no role
in explaining differences in standards of living.
c. Some countries can be rich mostly because of their
natural resources and countries without natural
resources need not be poor, but can never have very
high standards of living.
d. Abundant domestic natural resources may help make a
country rich, but even countries with few natural
resources can have high standards of living.
24. Which of the following provide benefits to society at
large and not just to the person(s) who pursues it?
a. technological knowledge that is a public good, but not
education
b. education, but not technological knowledge that is a
public good
c. neither education, nor technological knowledge that is
a public good
d. both technological knowledge that is a public good and
education
26. The dictator of Turan has recently begun to arbitrarily
seize farms belonging to his political opponents, and he
has given the farms to his friends. His friends don't
know much about farming. The courts in Turan have
ruled that the seizures are illegal, but the dictator has
ignored the rulings. Other things equal, we would
expect that the growth rate in Turan will
a. fall temporarily, but will return to where it was when the new
owners learn how to farm.
b. increase because the total amount of human capital in the
country will increase as the new owners learn how to farm.
c. fall and remain lower for a long time.
d. not be affected unless widespread civil disorder or civil war
results.
27 Which of the following is correct?
a. There is no debate about the effects of higher population
growth on economic growth.
b. Natural resources clearly place limits on growth; there is
simply no way to reduce either the amount or type of natural
resources needed to produce goods.
c. Economists argue that outward rather than inward policies
are likely to promote economic growth.
d. How much an increase in capital increases a country’s
output is independent of that country’s current level of
capital.
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28.
a.
b.
29.
a.
b.
30.
a.
b.
31.
a.
b.
If a country made it difficult for people to establish and prove the ownership of
their property, real GDP per person would likely rise
True
False
A country that made its courts more corrupt would likely see its standard of living
rise.
True
False
Other things the same, an economy’s factors of production are likely to be used
more effectively if there is an economy-wide respect for property rights.
True
False
The catch-up effect refers to the idea that poor countries, despite their best
efforts, are not likely ever to experience the economic growth rates of wealthier
countries.
True
False
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Conclusion
• In the long run
• Living standards are determined by productivity
• Policies that affect the determinants of productivity
• Will therefore affect the next generation’s living standards
• One of these determinants: saving & investment
• Next chapter: how saving and investment are determined, and
how policies can affect them
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Summary
• Gross Domestic Product (GDP) measures a country’s total income
and expenditure.
• The four spending components of GDP include: Consumption,
Investment, Government Purchases, and Net Exports.
• Nominal GDP is measured using current prices. Real GDP is
measured using the prices of a constant base year and is corrected
for inflation.
• GDP is the main indicator of a country’s economic well-being, even
though it is not perfect.
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Summary
• The Consumer Price Index is a measure of the cost of living. The
CPI tracks the cost of the typical consumer’s “basket” of goods &
services.
• The CPI is used to make Cost of Living Adjustments and to correct
economic variables for the effects of inflation.
• The real interest rate is corrected for inflation and is computed by
subtracting the inflation rate from the nominal interest rate.
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Summary
• There are great differences across countries in living standards
and growth rates.
• Productivity (output per unit of labor) is the main determinant of
living standards in the long run.
• Productivity depends on physical and human capital per worker,
natural resources per worker, and technological knowledge.
• Growth in these factors—especially technological progress—
causes growth in living standards over the long run.
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Summary
• Policies can affect the following, each of which has important
effects on growth:
• Saving and investment; International trade
• Education, health & nutrition
• Property rights and political stability
• Research and development
• Population growth
• Because of diminishing returns to capital,
growth from investment eventually slows down,
and poor countries may “catch up” to rich ones.
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