macro production growth
TRANSCRIPT
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MACROECONOMICS
Production and growth
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How productivity is determined?
The standard of living in an economydepends on the economys ability to
produce goods and services.Productivity, in turn, depends on theamount of physical capital, humancapital, natural resources and
technological knowledge available toworkers.
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Contd. Physical capital: The stock of equipment and
structures that are used to produce goods andservices is called physical capital or just capital.
Human capital: The knowledge and skills that workers
acquires through education, training and experience.Like physical capital human capital raises theeconomies ability to produce goods and services.
Natural resources: The inputs into the production ofgoods and services that are provided by nature, such
as land, rivers and mineral deposits. Technological knowledge: Societys understanding of
the best ways to produce goods and services.
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Economic growth and public policy: Government policy can try to
influence the economys growth ratein many ways, by encouragingsavings and investment, encouraginginvestment from abroad, fosteringeducation, maintaining propertyrights and political stability, allowing
free trade, promoting the researchand development of new technologiesand controlling population growth.
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For a closed economy:
Y = C + I + G
--H
ouseholds consume some of the economys output-- Firms and households use some of the output for
investment
-- The govt. buys some of the output for public purposes
We want to see how GDP is allocated among thesethree uses.
What determines the demand for
goods and services?
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Consumption (c) Disposable income: Y T
Households divide their disposable
income between consumption andsaving.
We assume that the level ofconsumption depends directly on thelevel of disposable income
C = C (Y-T)
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Consumption (C) Marginal Propensity to consumption
(MPC):
This implies the amount by whichconsumption changes whendisposable income increases by onedollar (taka).
0 < MPC < 1
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Consumption Function (c)The consumptionfunctionrelatesconsumption Cto disposable
income Y T.MPC is theamount bywhichconsumptionincreases whendisposable
incomeincreases byone taka.
MPC
Disposable income (Y-T)
Consumption,C
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Investment Function (I) The investment
function relates thequantity of investmentI to the real interestrate r.
Investment depends onthe real interest ratebecause the interestrate is the cost ofborrowing.
The investmentfunction slopes
downward. When theinterest rate rises,fewer investmentprojects are profitable.
Quantity of investment,I
Real interest rate, r
Investment
function,I(r)
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Government Purchases (G) G is the third component of DD for good &
services.
Purchases for defense
Services of government employees
Spending on infrastructure development
G = T Balance Budget
G>T Budget deficit G < T Budget surplus
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Equilibrium in the goods marketY = C + I + G
C = C (Y T)
I = I (r)
G = GT = T
Combining, Y = C (Y T) + I (r) + G
As G and T are fixed by policy,
Y = C (Y T) + I (r) + G
This equation states that the supply of output equals its demand
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Saving & Investment
In the National Income Accounts: National income accounting identities
reveal some important relationshipsamong macroeconomic variables. In
particular for a closed economy, nationalsaving must equals investment.Financial institution are the mechanismthrough which the economy matches
one persons saving with anotherpersons investment.
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Equilibrium in the financial marketY C G = I
S = I (S National saving)
S = Private saving + public saving= (Y T C) + (T G) = I
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Equilibrium in the financial market The interest rate adjusts
to bring saving andinvestment into balance.The vertical linerepresents saving the
supply of loanablefunds.
The downward slopingline representsinvestmentdemand
for loanable funds.
The interesction of thesetwo lines determines theequilibrium interestrates.
I(r)
Sr
I, S
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Changes in saving:
The effects of fiscal policy (G, T) The increase in G causes
interest rate to increase andinvestment to decrease.Decrease in T will have thesame effect
When government budgetdeficit crowds out investment(i.e. fall in investment
because of governmentborrowing is called crowingout), it reduces the growth of
productivity and GDP.
A decrease in tax raisesdisposable income by T,consumption goes up byMPC x T. National savingfalls by the same amount asconsumption rises. So,supply of loanable funds shiftto the left, which increasesthe interest rate and crowsout investment.
r1
r2
S1
S2
I(r)
I, S
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Changes in saving:
The effects of fiscal policy (G, T) Government budget
surpluses work just the
opposite as budget deficit.
Thus , a budget surplus (i.e.
T > G) increases the supplyof loan able funds, reduces
the interest rate, and
stimulates investment.
Higher investment, in turn,
means greater capitalaccumulation and more
rapid economic growth.
r1
r2
S1
S2
I(r)
I, S