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Lecture 7: The Real Economy in the Long Run

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Lecture 7: The Real Economy in the Long Run Production & Growth Savings, Investment & the Financial System The Natural Rate of Unemployment PRODUCTION AND GROWTH The ... – PowerPoint PPT presentation

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Title: Lecture 7: The Real Economy in the Long Run


1
Lecture 7 The Real Economy in the Long Run
  1. Production Growth
  2. Savings, Investment the Financial System
  3. The Natural Rate of Unemployment

2
PRODUCTION AND GROWTH
3
The Benefits of Growth
  • Creation of new jobs for growing population
  • Satisfy increasing aspirations through the
    provision of more and better goods and services
  • Contributes to social political stability

4
Productivity
  • Productivity is the key determinant of growth
  • Productivity refers to the quantity of goods and
    services that a worker can produce from each hour
    of work.

5
The Factors of Production
  • Physical capital
  • Human capital
  • Natural resources
  • Technological knowledge

6
Physical Capital
  • The stock of equipment and structures that are
    used to produce goods and services.
  • Tools used to build or repair automobiles.
  • Tools used to build homes or buildings.
  • Office buildings, schools, etc.

7
Human Capital
  • The knowledge and skills that workers acquire
    through education, training, and experience.
  • Like physical capital, human capital raises a
    nations ability to produce goods and services.

8
Natural Resources
  • Inputs used in production that are provided by
    nature, such as land, rivers, and mineral
    deposits.
  • Renewable resources include trees and forests.
  • Non-renewable resources include petroleum and
    coal.

9
Technological Knowledge
  • Technological knowledge is the understanding of
    the best ways to produce goods and services.
  • This is used to increase the value of human
    capital.

10
The Production Function
  • A production function describes the relationship
    between the quantity of inputs used in production
    and the quantity of output from production.

11
The Production Function
  • Y A F(L, K, H, N)
  • Y quantity of output
  • A available production technology
  • L quantity of labour
  • K quantity of physical capital
  • H quantity of human capital
  • N quantity of natural resources
  • F is a function that shows how the inputs are
    combined.

12
Government Policies That Raise Productivity and
Living Standards
  • Encourage saving and investment.
  • Establish secure property rights and maintain
    political stability.
  • Encourage education and training.
  • Promote free trade.
  • Promote research and development.
  • Control population growth.

13
SAVING, INVESTMENT AND THE FINANCIAL SYSTEM
14
The Financial System
  • The financial system consists of institutions
    that help to match one persons saving with
    another persons investment.
  • It moves the economys scarce resources from
    savers to borrowers.

15
Types of Financial Institutions in the
Australian Economy
  • Financial Markets
  • Stock Market
  • Bond Market
  • Financial Intermediaries
  • Banks
  • Managed Funds

16
The Bond Market
  • A bond is a certificate of indebtedness that
    specifies obligations of the borrower to the
    holder of the bond.

17
Characteristics of a Bond
  • Term The length of time until maturity.
  • Credit Risk The probability that the borrower
    will fail to pay some of the interest or
    principal.
  • Tax Treatment The way in which the tax laws
    treat the interest on the bond.
  • In Australia interest earned on bonds is treated
    as any other form of income and is taxed. In the
    U.S. Municipal bonds are federal tax exempt.

18
The Stock Market
  • A share is a claim to partial ownership in a
    firm.
  • The sale of stock to raise money is called equity
    financing.
  • Compared to bonds, shares offer both higher risk
    and potentially higher returns.

19
Financial Intermediaries Banks
  • Banks take deposits from people who want to save
    and make loans to people who want to borrow.
  • Banks pay depositors interest and charge
    borrowers slightly higher interest on their
    loans.
  • Banks help create a medium of exchange by
    allowing people to write cheques against their
    deposits.

20
Financial Intermediaries Mutual Funds
  • A managed fund is an institution that sells
    shares to the public and uses the proceeds to buy
    a selection, or portfolio, of various types of
    stocks, bonds, or both.
  • They allow people with small amounts of money to
    easily diversify.

21
Other Financial Institutions
  • Credit unions
  • Pension funds
  • Insurance companies
  • Loan sharks

22
Saving and Investment in the National Income
Accounts
  • Recall Y C I G NX
  • In a closed economy
  • Y C I G
  • Total income in the economy after paying for
    consumption and government purchases is called
    national saving, or just saving. Therefore it is
    assumed that
  • S I

23
Private Saving
  • Private saving is the amount of income that
    households have left after paying their taxes and
    paying for their consumption.
  • Private saving (Y T C)

24
Public Saving
  • Public saving is the amount of tax revenue that
    the government has left after paying for its
    spending.
  • Public saving (T G)

25
Supply and Demand for Loanable Funds
  • The supply of loanable funds comes from people
    who have unspent income
  • The demand for loanable funds comes from those
    who wish to borrow to make investments.
  • The equilibrium of the supply and demand for
    loanable funds determines the real interest rate.

26
Supply and Demand for Loanable Funds
27
Taxes and Saving
  • Taxes on savings reduce the incentive to save.
  • A tax decrease increases the incentive for
    households to save at any given interest rate.
  • The supply of loanable funds curve shifts to the
    right.
  • The equilibrium interest rate decreases.
  • The quantity demanded for loanable funds
    increases.

28
An Increase in the Supply of Loanable Funds
Supply, S1
S2
1. Tax incentives for saving increase the supply
of loanable funds...
5
4
2. ...which reduces the equilibrium interest
rate...
Demand
1,200
1,600
Loanable Funds (in billions of dollars)
0
29
A Tax Credit
  • An investment tax credit increases the incentive
    to borrow.
  • Increases the demand for loanable funds.
  • Shifts the demand curve to the right.
  • Results in a higher interest rate and a greater
    quantity saved.

30
An Increase in the Demand for Loanable Funds
Supply
1. An investment tax credit increases the demand
for loanable funds...
6
5
2. ...which raises the equilibrium interest
rate...
D2
Demand, D1
1,200
1,400
0
Loanable Funds (in billions of dollars)
3. ...and raises the equilibrium quantity of
loanable funds.
31
Budget Deficits
  • When the government spends more than it receives
    in tax revenues, the short fall is called the
    budget deficit.
  • The accumulation of past budget deficits is the
    government debt.
  • Government borrowing reduces the supply of
    loanable funds available to finance investment by
    households and firms.

32
The Effect of a Government Budget Deficit
S2
Supply, S1
1. A budget deficit decreases the supply of
loanable funds...
6
5
2. ...which raises the equilibrium interest
rate...
Demand
800
1,200
Loanable Funds (in billions of dollars)
0
3. ...and reduces the equilibrium quantity of
loanable funds.
33
Conclusions
  • Financial markets are like other markets in the
    economy.
  • The real interest rate is governed by the forces
    of supply and demand.
  • Financial markets coordinate borrowing and
    lending, helping to allocate the economys scarce
    resources efficiently.
  • The Australian financial system includes
    financial institutions such as the bond market,
    the stock market, banks, and managed funds.

34
Conclusion
  • National saving equals private saving plus public
    saving.
  • A government budget deficit represents negative
    public saving, reducing national saving and the
    supply of loanable funds.
  • It crowds out investment and reduces growth and
    GDP.

35
THE NATURAL RATE OF UNEMPLOYMENT
36
Categories of Unemployment
  • The problem of unemployment is usually divided
    into two categories.
  • The natural rate of unemployment
  • The cyclical rate of unemployment

37
Natural Rate of Unemployment
  • The natural rate of unemployment is unemployment
    that does not go away on its own even in the long
    run.
  • It is the amount of unemployment that the economy
    normally experiences.

38
Cyclical Unemployment
  • Cyclical unemployment refers to the fluctuations
    in unemployment around its natural rate.
  • It is associated with with short-term ups and
    downs of the business cycle.

39
The Australian Unemployment Rate Since 1970
40
Explaining unemployment
  • Minimum-wage laws
  • Unions
  • Efficiency wages
  • Job search

41
Minimum-Wage Laws
Wage
Minimum wage
WE
Quantity of labour
LE
0
LD
LS
42
Theory of Efficiency Wages
  • Efficiency wages are above-equilibrium wages paid
    by firms in order to increase worker productivity
  • Attempts to attract the competent worker
  • Raises wage level above equilibrium
  • Can contribute to unemployment

43
Reasons for paying Efficiency Wages
  • Worker Health Better paid workers are more
    productive.
  • Worker Turnover A higher paid worker is less
    likely to look for another job.
  • Worker Effort Higher wages motivate workers to
    put forward their best effort.
  • Worker Quality Higher wages attract a better
    pool of workers to apply for jobs.

44
Unions and Collective Bargaining
  • By acting as a cartel with ability to strike or
    otherwise impose high costs on employers, unions
    usually achieve above equilibrium wages for their
    members.

45
The Effect of Union Bargaining
  • Critics argue that unions cause the allocation of
    labour to be inefficient and inequitable.
  • Wages above the competitive level reduce the
    quantity of labour demanded and cause
    unemployment.
  • Some workers benefit at the expense of other
    workers.

46
The Effect of Union Bargaining
  • Advocates of unions contend that unions are a
    necessary antidote to the market power of firms
    that hire workers.
  • They claim that unions are important for helping
    firms respond efficiently to workers concerns.

47
Job Search Unemployment
  • Job search is the process by which workers find
    appropriate jobs given their tastes and skills.
  • Job search unemployment results from the fact
    that it takes time for qualified individuals to
    be matched with appropriate jobs.

48
The Inevitability of Job Search Unemployment
  • Search unemployment is inevitable because the
    economy is always changing.
  • Changes in the composition of demand among
    industries or regions are called sectoral shifts.
  • It takes time for workers to search for and find
    jobs in new sectors.

49
Public Policy and Job Search
  • Government programs can affect the time it takes
    unemployed workers to find new jobs.
  • These programs include the following
  • Government-run employment agencies
  • Public training programs
  • Unemployment benefits

50
Conclusion
  • The unemployment rate is the percentage of people
    who would like to work but dont have jobs.
  • Most unemployment in Australia is attributable to
    a few people who are unemployed for long periods
    of time.

51
Conclusion
  • Minimum-wage laws can create excess labour supply
    and cause unemployment.
  • The market power of unions can cause unemployment
    by pushing wages above the equilibrium level.

52
Conclusion
  • The payment of efficiency wage and the time
    involved for workers to search for suitable jobs
    are other reasons for unemployment.
  • Unemployment benefits may increase the amount of
    search unemployment but they reduce poverty and
    may increase workers chances of being matched
    with the right jobs.

53
Self-Test (Hakes Parry) Chapter 9
  • Match all Terms Definitions
  • Answer questions 1-2 of the Practice Problems
  • Answer Short Answer questions 1, 2, 4, 7, 9 10
  • Do all True/False Questions
  • Answer Multiple Choice Questions 1, 2, 4, 6, 8,
    9, 10, 12, 13, 15, 18, 19 20
  • Make notes on the Advanced Critical Thinking
    questions
  • Check answers in guide and revise accordingly

54
Self-Test (Hakes Parry) Chapter 10
  • Match all Terms Definitions
  • Answer questions 1, 2 3 of the Practice Problems
  • Answer Short Answer questions 2,3,6,7,8,11,13 9
  • Do all True/False Questions
  • Answer Multiple Choice Questions 1, 3, 4, 7, 8,
    9, 11, 13, 15 20
  • Make notes on the Advanced Critical Thinking
    questions
  • Check answers in guide and revise accordingly

55
Self-Test (Hakes Parry) Chapter 11
  • Match all Terms Definitions
  • Answer questions 1-3 of the Practice Problems
  • Answer Short Answer questions 1, 2, 4, 5, 6, 7,
    8, 10 11
  • Do all True/False Questions
  • Answer Multiple Choice Questions 1, 2, 4, 7, 8,
    9, 11, 12, 14, 17, 18 20
  • Make notes on the Advanced Critical Thinking
    questions
  • Check answers in guide and revise accordingly

56
Reading
  • This week Text and Study Guide Chapters 9, 10
    11
  • For next lecture Chapters 12 13
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