PSCI 1500: Introduction to Economics

Macroeconomic Goal: Economics Growth

IMPORTANT TERMS

i. Production - refers to the creation of goods and services.

ii. Full Production - occurs when an economy is producing at its maximum capacity, or when it is experiencing full employment.

iii. Economic Growth - increase in economy’s full production output level over time.

GRAPHICAL ILLUSTRATION

Graphical Illustration : Full Production & Economic Growth

A nation’s standard of living is determined by the productivity of its workers.

Productivity refers to the quantity of goods and services that a worker can produce from each hour of work.

Thus, to understand the large differences in living standards across countries, the focus lies on the production of goods and services.

WHY PRODUCTIVITY IS SO IMPORTANT?

THE CONCEPT OF PRODUCTIVITY

ProductivityConcept of assessing the amount of output produced by economy’s resources, increase when resources increases (advancement, capability, quantity etc.)

Often measures specifically by output per worker.

HOW PRODUCTIVITY IS DETERMINED

The resources or inputs used to produce goods and services are called the factors of production.

These factors of production directly determine productivity.

Measures of Production

Gross Domestic Product (GDP) - Dollar figure that measure the values of all finished goods & services produced in an economy in a year; excluding products in progress, secondhand sales, stocks or bonds.

MEASURES OF PRODUCTION

Measures of Production2 types of GDP

i. Nominal GDP (Money GDP)•Measures the value of production in terms of prices at the time of production.• Affected by changes in price and production.

ii. Real GDP (Constant GDP)•Money GDP adjusted to eliminate inflation.• Shows how the actual production change without influence of price change.

MEASURES OF PRODUCTION

Underground EconomyProductive activities that are not reported for tax purposes and are not included in GDP.

• Nonmarket productive activitiesVolunteer work, maintaining your car, etc.

• Unreported workMowing lawns, full-time housecleaning, tips, etc.

• Swapped servicesDental work in exchange for legal advice.

MEASURES OF PRODUCTION

Indicate whether the following transactions are included or excluded in calculating the GDP.

Income from a company trading drugs substance which is used for licensed medicine• Included - productive transaction, legal

A man bought health care product for his father • Included– involve direct transactions, new goods

A teenager helps wash his father’s car and get paid • Excluded - not reported for tax purpose

A farmer purchase used tractor for his new farm land• Excluded - second hand, transactions already

occurred

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THE GDP GAP

The GDP Gap (output gap)

The difference between potential GDP and actual GDP or actual output

Y*–Y = GDP GapY* is actual GDP/output Y is potential GDP/output

• Actual GDP - what the country actually produces• Potential GDP - what the economy would

produce if all its resources were fully utilized

THE GDP GAP

Recall that Y* is actual GDP/output while Y is potential GDP/output

• If Y*–Y yields a positive number (inflationary gap) • Y* > Y inflation tends to rise

• If Y*–Y yields a negative number (recessionary gap)• Y* < Y downward pressure on inflation, signifying deflation.

THE FACTORS OF PRODUCTION

Physical capitalHuman capitalNatural resourcesTechnological knowledge

THE FACTORS OF PRODUCTION

Capital is a produced factor of production.

It is an input into the production process that in the past was an output from the production process.

PHYSICAL CAPITAL

Physical capital is 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 furniture. Office buildings, schools, etc.

HUMAN CAPITAL

Human capital is the economist’s term for the knowledge and skills that workers acquire through education, training, and experience.

• Like physical capital, human capital raises a nation’s ability to produce goods and services.

Natural resources are inputs used in production that are provided by nature, such as land, rivers, and mineral deposits.• Renewable resources include trees and forests.

• Nonrenewable resources include petroleum and coal.

• Natural resources can be important but are not necessary for an economy to be highly productive in producing goods and services.

NATURAL RESOURCES

TECHNOLOGICAL KNOWLEDGE

Technological knowledge is the understanding of the best ways to produce goods and services.

Human capital refers to the resources expended transmitting this understanding to the labor force.

Governments can do many things to raise productivity and living standards.

Encourage saving and investment. Encourage investment from abroad Encourage education and training. Secure property rights and maintain

political stability.Promote free trade.Control population growth.Promote research and development.

ECONOMIC GROWTH AND PUBLIC POLICY

SAVING AND INVESTMENT

One way to raise future productivity is to invest more current resources in the production of capital.

Governments can increase capital accumulation and long-term economic growth by encouraging investment from foreign sources.

Governments can increase capital accumulation and long-term economic growth by encouraging investment from foreign sources.

EDUCATION

• For a country’s long-run growth, education is at least as important as investment in physical capital.• Study shows that in the US, each year of schooling

raises a person’s wage on average by about 10%.• Thus, the government can enhance the standard of

living is to provide schools and encourage the population to take advantage of them.

• An educated person might generate new ideas about how best to produce goods and services, which in turn, enter society’s pool of knowledge and provide an external benefit to others.

• However, one problem facing some poor countries is the brain drain i.e. the emigration of many of the most highly educated workers to rich countries.

PROPERTY RIGHTS AND POLITICAL STABILITY

Property rights refer to the ability of people to exercise authority over the resources they own.

• An economy-wide respect for property rights is an important prerequisite for the price system to work.

• It is necessary for investors to feel that their investments are secure.

FREE TRADE

Trade is, in some ways, a type of technology.

A country that eliminates trade restrictions will experience the same kind of economic growth that would occur after a major technological advance.

CONTROL OF POPULATION GROWTH

Population is a key determinant of a country’s labor force.

• Large populations tend to produce greater total GDP.

• However, GDP per person is a better measure of economic well-being, and high population growth reduces GDP per person.

RESEARCH AND DEVELOPMENT

The advance of technological knowledge has led to higher standards of living.

• Most technological advance comes from private research by firms and individual inventors.

• Government can encourage development of new technologies through research grants, tax breaks, and the patent system.

1. Identify among the government policies to promote economic growth.

2. How do you think the influx of more women in the universities may influence the economy?

REVIEW