Macro Production Growth

8/6/2019 Macro Production Growth

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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

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Macro Production Growth