econ 1102 week 12 post lecture

7/21/2019 ECON 1102 Week 12 Post Lecture

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The Open EconomyEconomic Growth

Read Chapter 10 & 11

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1. What is economic growth?

2. What determines economic growth

3. How to promote economic growth4. Costs/limits to growth?

5. Developing a model of economic growth

Read: Bernanke Chapter 10 and Chapter 11

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Record of transactions between residents of a country andnon-residents

Current Account

Transactions leading to a change of ownership ofcommoditiesor a direct flow of income

Capital Account

Transactions involving the purchase or sale of

assets

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Balance on merchandise trade(exports less imports ofgoods)

(plus) Net services

(plus) Net income(includes labour and propertyincome; interest, dividend and royalty payments)

(plus) Current transfers(migrant funds, foreign aid)

(equals) Balance on Current Account

When the balance is negative, it is known as acurrent account deficit; when positive, a current

account surplus

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That part of the balance of payments that recordstransactions leading to a change of ownership ofcommodities, or a direct flow of income or similarpayment, is known as:

A. net external assets

B. the current account

C. the balance on merchandise trade

D. terms of trade

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That part of the balance of payments that recordstransactions leading to a change of ownership ofcommodities, or a direct flow of income or similarpayment, is known as:


B.the current account


D. terms of trade

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That part of the balance of payments that recordstransactions leading to either the purchase or sale ofdomestic assets is known as:




D. the capital account

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That part of the balance of payments that recordstransactions leading to either the purchase or sale ofdomestic assets is known as:




D.the capital account

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Which of the following is a debit item in the Australian currentaccount?

A. The sale of wool to Italy

B. An Australian consulting company receives payment from anoverseas firm

C. The fees paid by overseas students at an Australian university

D. An Australian company pays for consulting services from anoverseas firm

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Which of the following is a debit item in the Australian currentaccount?

A. The sale of wool to Italy

B. An Australian consulting company receives payment from anoverseas firm

C. The fees paid by overseas students at an Australian university

D.An Australian company pays for consulting services from anoverseas firm

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The capital and financial accountincludes the capital

account and the financial account. The capital account(is very small and) includes:

Net capital transferswhich include (eg) the

cancellation of debts of poor countries and funds

taken in and out by migrants; and

The net acquisition/disposal of non-produced, non-

financial assets records sales of embassy land or

patents and copyrights etc.

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The capital and financial accountincludes the capitalaccount and the financial account.

The financial accountis (the major component and is) divided

between two sectors:

The official sectorrecords the transactions of thegovernment sector and the Reserve Bank.

The non-official sector records the transactions of private

sector firms, financial institutions and householdsdirect

and portfolio investment balances of net foreigninvestment in Australia and Australian investment abroad

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When an Australian company purchases a timber mill inBosnia, from the perspective of Australia this is a(n):

A. import

B. export

C. balance on merchandise trade

D. capital outflow

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When an Australian company purchases a timber mill inBosnia, from the perspective of Australia this is a(n):

A. import

B. export

C. balance on merchandise trade

D.capital outflow

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If Australia has a $30 billion current account deficit, thenthere must be:

A. net capital inflows of $30 billion

B. net capital inflows of -$30 billion

C. no capital inflows or capital outflows

D. net capital outflows of $30 billion

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If Australia has a $30 billion current account deficit, thenthere must be:

A.net capital inflows of $30 billion

B. net capital inflows of -$30 billion

C. no capital inflows or capital outflows

D. net capital outflows of $30 billion

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Relative domestic and foreign interest rates

Relative riskinessdue to

Risk of loss of capital (political risk, default by borrower,

bankruptcy by foreign business) Exchange rate risk

Expected long term returns

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Holding constant risk and the real returns available abroad,lower domestic real interest rates _____ capital inflows,

_____ capital outflows and _____ net capital inflows.

A. increase; increase; increase

B. increase; increase; decrease

C. increase; decrease; increase

D. decrease; increase; decrease

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Holding constant risk and the real returns available abroad,lower domestic real interest rates _____ capital inflows,

_____ capital outflows and _____ net capital inflows.

A. increase; increase; increase

B. increase; increase; decrease

C. increase; decrease; increase

D.decrease; increase; decrease

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In a closed economy, we have seen that national savingand investment are equal.

In an open economy, where capital flows are possible,

savings from other countries can finance domestic

investments.

Therefore, we can write:NS+KI=I


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Let a country's national saving (NS), investment (I) and net

capital inflows (KI) be given by the following:NS= 2000 + 2000*rI= 2500 - 4000*rKI= -100 + 6000*rwhere ris the real interest rate. If this is a closed economy,what is the equilibrium real interest rate?

A. 0.083

B. 0.050

C. 0.000

D. 0.025

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Let a country's national saving (NS), investment (I) and net capitalinflows (KI) be given by the following:NS= 2000 + 2000*rI= 2500 - 4000*rKI= -100 + 6000*rwhere ris the real interest rate. If this is a closed economy, what isthe equilibrium real interest rate?

A.0.083 NS = I (no capital inflow)2000 + 2000r = 2500 4000r

6000r = 500r = 0.083

B. 0.050

C. 0.000

D. 0.025

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.

p

0Output

LRAS1

SRAS

AD

LRAS2

SRAS

AD

Y*1 Y*2

Rightward shift of LRAC


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long term growth refers to a rise in living standards,not the rise in total GDP

material living standards are reflected in GDP per

capita http://www.smh.com.au/business/the-

economy/australias-gdp-figures-beat-expectations-20140305-346c5.html

http://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.html

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http://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/federal-politics/political-news/countrys-rich-have-lions-share-of-income-growth-20131009-2v8q2.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.htmlhttp://www.smh.com.au/business/the-economy/australias-gdp-figures-beat-expectations-20140305-346c5.html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Figure 10.1 Ratio of real per capita GDP to 1960 real per capita GDP


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Figure 10.2 Distribution of world real per capita GDP, 2007


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Figure 10.3 Average annual growth rates of

real per capita GDP, 19902007, selected

Sub-Saharan African

countries, Australia and the United States

Figure 10.4 Average annual growth

rates in per capita real GDP 19602007

for three of the Asian Tigers


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Large differences in growth rates

Large differences in real GDP per capita

Small differences in annual growth rates matter

Why do countries grow at different rates?


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Long term growth refers to growth in GDP percapita

GDP per capita = Y/POP

But, Y/POP = Y/N x N/POP

Where: in long run Y = Y* = real output;

N = number of employed workers

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Long term growth refers to growth in GDP percapita

GDP per capita = Y/POP

But, Y/POP = Y/N x N/POP

Where: in long run Y = Y* = real output;

N = number of employed workers

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GDP per worker = average labour productivity

Share of population working


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Growth of labour productivity (Y/N)

Growth of worker/population ratio (N/POP)

Accordingly, real GDP can only grow if: the average labour productivity grows; and/or

the share of the working population grows.

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Figure 10.8 Share of the Australian population employed and average productivity,

19642010


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Human capital per worker

Physical capital per worker

Land and natural resources per worker

The level of technology Entrepreneurship and quality of management

Incentives provided by the taxation and welfare

systems e.g. retirement pension age Political and legal environmente.g. property rights

Social norms e.g. childcare, family size

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Age distribution of the population- birth rate, death rate, immigration

- http://www.bbc.com/news/magazine-25968269

Long term trends affecting participation in the labour

force-Working parents, retirement ages, years in education etc

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http://www.bbc.com/news/magazine-25968269http://www.bbc.com/news/magazine-25968269http://www.bbc.com/news/magazine-25968269http://www.bbc.com/news/magazine-25968269


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Human capital: policies to improve education, trainingand research

Physical capital: policies to enhance saving and

increase investment

Level of technology: policies to increase research and

development

Other: sensible regulation, enforcement of property

rights, transparent government and justice system

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Costs of economic growth?:future consumptionpossibilities only possible at expense of current consumption

(ie, elderly sacrifice for the young), environmental damage

Limits to growth?:is economic growth limited due toenvironmental impacts and ongoing population growth?

- Environmental concernsconsider technological

improvements, higher wealth -> better solutions; use the

market to address mis-pricing of energy sources- Population growth concernsricher countries have smaller

families

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A Production Functionrepresents the relationshipbetween

Primary Factors of Production

Labour

Capital Secondary Factors of Production

Technology

Management Expertise

Skills Other Factors e.g. infrastructure, political stability etc..

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Figure 11.1 The production process


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The production function shows the level of productionassociated with different combinations of capital and

labour, holding secondary factors constant

As well, with inputs of labour and capital constant, itshows the level of production with different inputs of

secondary factors

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Capital is a key determinant in economic growth.

The real rate of interest in the economy is anopportunity cost of employing capital.

It is a rate of interest the firm needs to pay if borrowing funds,or a rate it could receive if it saved those funds instead.

A key question is how much capital the firm

should acquire. It is determined by the cost-benefit principle.


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Figure 11.3 The diminishing marginal productivity of capital


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Fig. 11.4 The demand for capital

Marginal benefit (marginal product of capital)

= Marginal cost (real interest rate)


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When using the production function, economists uselabour, l, as the total number of hours or work

supplied.

Individuals decide how much labour they supply by

comparing the benefits of workingthe real wage

received against the cost of workingand choosing the

best alternative to their time.


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The factors that affect a firms demand for labour aresimilar to the factors that affect a firms choice of the

capital stock. The benefits to the firm of employing an additional unit of

labour are measured by the marginal revenue product of

labour:MRPl=P xMPl

As with capital, theMPl andMRPldecline due to thefact that: successive workers are assigned to the most productive

tasks the pragmatic problems of adding more staff to fixed capital.


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Determines equilibrium

amount of labour


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The production function shows how firmscombine those primary factors of productionto produce output:

Assumptions on the production function: Adding more capital to fixed labour increases total

product but decreases marginal productivity.

Adding more labour to fixed capital increases totalproduct but decreases marginal productivity.

All secondary factors of production, such asmanagerial expertise and the skill level of thelabour, remain constant.


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Yt=AtKt. Lt

(1 )

Y= amount of real output

K= capital stockL= amount of labour

A= secondary factors of production

0 < a< 1

indicates share of capital, 1- indicates share of labour

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Yt=AtKt. Lt

(1 )

Y= amount of real output

K= capital stockL= amount of labour

A= secondary factors of production

0 < a< 1

indicates share of capital, 1- indicates share of labour

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Production in period t (Yt)depends on the secondary factors of

production in period t (At),multiplied by a function of

the combination of the employment of

capital and labour in period t (Ktand Lt).


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Based on the observation that the shares of capital income ()

and labour income (1) in US national income have been

more or less constant over time

Widely used (around the world) to represent the production

function in empirical work

Has useful properties:

Displays diminishing marginal productivity for both labour

and capital

Features constant returns to scale (ie, if double inputs of Kand L, then output is doubled)

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Yt=AtKt

. Lt(1

)

LetA= 5

= 0.2 , (1) = 0.8

L = K= 1 in period t =1

1. Keeping labour (L) constant at 1, how will output change as

the quantity of capital (K) increases from 1 to 2, 3, 4, 5?

2. What happens to output when labour and capital eachincrease from 1 to 5 ?

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t = At Kt Lt Yt = At.Kta.Lt(1-a) MPk

1 5 1 1 Y1 = 5 x 10.2 x 1(1-0.2) = 5

2 5 2 1 5.74 0.74

3 5 3 1 6.23 0.49

4 5 4 1 6.60 0.37

5 5 5 1 6.90 0.30

Diminishing marginal productivity of capital


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t = At Kt Lt Yt = At.Kta.Lt(1-a)

1 5 1 1 Y1 = 5 x 10.2 x 1(1-0.2) = 5

2 5 2 2 Y1

= 5 x 20.2 x 2(1-0.2) = 10

3 5 3 3 15

4 5 4 4 20

5 5 5 5 25

Constant returns to scale


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Start with our Cobb-Douglas function:

yt=Atktlt(1)

Given a 1% increase in the capital stock between one

period and the next, how much will output increase?

We will use the mathematical rule that ifZ=X, thena percentage change inZ= (the percentage change in

X).


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yt kt= yt -1 kt -1

The LHS is the economys rate of growth. The RHS

shows us that if = 0.25 (which is the share of GDP

paid to owners of capital) then a 1% increase in the

capital stock will lead to a 0.25% increase in growth.


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The same type of reasoning shows us how outputwould change if all else is constant and the labour

supply changes:

yt lt= (1 )yt -1 lt -1

If = 0.25 then a 1% increase in the labour supply will

lead to a 0.75% increase in growth.


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The secondary factors of production are knowncollectively as total factor productivity because theyimpact on the ability to transform primary factorsinto output.

We can calculate the contribution to growth by:

yt At=yt-1 At -1

This is a one-to-one relationship: if TFP increased by1% there would be a 1% increase in growth.


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Economic growth occurs either because the capital

stock has grown, the labour supply has grown, or

there has been an improvement in the economys

ability to use labour and capital.


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Example: If capital was growing at 4% pa, labour at 1%,TFP at 1% and = 0.25, we could calculate the

economic growth rate at 2.75%. Capital would have

contributed 0.25 x 4% = 1%, labour 0.75 x 1% = 0.75%

and TFP 1 x 1% = 1%.

In reality, information on capital stock is difficult to

calculate accurately, but is available. Data on labour,

economic growth and the value of are available and

reasonably accurate.


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Figure 11.11 Growth accounting, Australia, 1976 to 2009


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Figure 11.12 Growth accounting, Japan, the United Kingdom and the United States


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Figure 11.13 Growth accounting, the Asian Tigers and the Philippines, 19601994


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Highlight factors influencing total factor productivity (TFP)

Education and human capital

Research and development

Political structure

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PART A: 45 Multiple choice questions 45 marks (1 mark each)

PART B : 2 Written question (in parts)

2 x 10 marks = 20 marks

ANSWER ALL QUESTIONS

Refer to Moodle for more detail

Sample questions (Part B) on Moodle

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Go over the post lecture notes on Moodle Go over Tutorial questions

Do sample written questions on Moodle

Do MC quizzes on Moodle

Attend Pitstop session for extra help

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GOOD LUCK IN YOUR EXAMS

econ 1102 week 12 post lecture

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