ECON102 Midterm EXAM AID

Tutor: Ming Zhou

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Agenda

Chapters 7– Productivity– Economic Growth and Public Policy

Chapter 8– Saving and Investment– Market for Loanable Funds

Chapter 9– Unemployment

Chapter 10– Money– Bank of Canada

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Chapter 7Production and Growth

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Productivity

Definition: Average output per worker

ORY/L where Y = Real GDP, L = Quantity of Labour

Very important in determining the living standard for a country.

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Factors of Production

The Factors of Production:– Physical capital (K)

Equipment, Machine

– Human capital (H)Education, Training

– Natural resources (N)Oil, gas

– Technological knowledge (A)Societal understanding of how to produce efficiently

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Production Function

Y = A F(L, K, H, N)Productivity Function:Y/L = A F(1, K/L, H/L, N/L)

*Follows constant returns to scale*A is multiplied by the entire function

Ex. 3Y = A F(3L, 3K, 3H, 3N)2Y = 2A F(L, K, H, N)

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Public Policies

1. Encourage saving and investment.• Tradeoff between higher consumption

now or higher consumption in the future (K/L+)

• Affected by law of diminishing returns (Catch-up effect)

7K/L

Y/L

Public Policies

2. Encourage investment from abroad• Foreign direct investment (foreign capital)• Foreign portfolio investment (foreign

money)• Beneficial to poor countries (A+)

3. Encourage education and training• Increases human capital (H/L+)

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Public Policies

4. Establish secure property rights and maintain political stability• Gives more incentive for companies to

invest in capital and technology (H/L+, A+)

5. Promote free trade.• Outward-oriented policies > Inward-

oriented policies (A+)

6. Promote research and development.• Overall technology level increases (A+)

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Population Growth

1. Depleting natural resources• Non-renewable resources are used up

(N/L-)• Possibly encourages alternatives (A+)

2. Diluting the capital stock• Lower productivity due to more workers

for the same amount of capital (K/L-, H/L-)

3. Developing new technology• More people = more intellectuals who

make discoveries (A+)10

Chapter 8

Saving, Investment, and the Financial System

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Saving and Investment

*Assuming a closed economyI = Y – C – G

• Income left after consumption and government purchases are made (national savings (S))

S = IS = (Y – T – C) + (T – G)

*T = amount of taxes collected – transfer payments made

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Saving and Investment

Private Saving = (Y – T – C)• Household income after paying taxes and

consumption

Public Saving = (T – G)• Government tax revenue left after paying for

its spending

*S = Private Saving + Public Saving

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Budget Surplus and Deficit

Budget Surplus• Excess of tax revenue after government

spending• T – G is a positive number

Budget Deficit• Shortfall of tax revenue from government

spending• T – G is a negative number

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Market for Loanable Funds

Financial market for funds supplied by savers and demanded by investors

• LFs = loanable funds supply comes from savings decisions

• LFd = loanable funds demand comes from borrowing decisions

• Interest rate = cost of borrowing = return to savings

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Government Policies

1. Saving Incentives– Lower tax on interest income will cause

LFs to shift right

2. Investment Incentives– Tax credit on investment spending will

cause LFd to shift right

3. Government Budget Deficits– Borrowing from the government lowers

LFs available to households and firms (crowding out)

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Chapter 9Unemployment and its Natural Rate

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Unemployment

Cyclical Unemployment• Unemployment associated with the

business cycle (short term)

Natural Rate of Unemployment • Unemployment that always exists in the

economy (long term)• Between 6-8% in Canada

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How is it measured?

Adults (15+) are placed into 3 categories:• Employed (has a paid job in which they

spend the majority of their previous week)• Unemployed (laid off, looking for job,

waiting for a new job)• Not in the labour force

The labour force is the sum of employed and unemployed.

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How is it measured?

Unemployment rate:(% of labour force that is unemployed)

Labour force participation rate:(% of adult population that is in the labour force)

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How is it measured?

Problems with the measurement:• Discouraged searchers• Financial assistance

– Less incentive to work

• Underemployed– High education, part-time jobs

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Causes for unemployment

• Frictional Unemployment – caused by the job search process

• Cyclical Unemployment – short-run economic fluctuations

• Structural Unemployment – not enough jobs in the labour market (Qs > Qd)

*Large % of unemployed is short term, with a small % being long term

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Frictional Unemployment

Sectoral Shifts:Constant change in the demand for labour

• Industries – increase/decrease in demand for labour which produces certain goods/services

• Regions – increases in the demand for labour in one region and decreases in the demand for labour in other regions of the economy

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Minimum-Wage Laws

• Occurs when the wage is set at a level above the equilibrium

• Creates a situation where quantity of labour supplied is greater than quantity of labour demanded– Unemployment for least skilled and

inexperienced

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Unions

Union• worker association that negotiates with

employers for better wages/working conditions

Collective Bargaining• Process in which agreement for employment

terms are reached between firms and unions

Strike• Withdrawal of labour when collective

bargaining fails 25

Theory of Efficiency Wages

• Increases productivity by having above-equilibrium wage– Worker Health goes up– Worker Turnover goes down– Worker Effort goes up– Worker Quality goes up

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Chapter 10The Monetary System

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Functions of Money

1. Medium of exchange• Something the buyer gives to the seller to

purchase a good or service (eliminates double coincidence of wants)

2. Unit of account• Allows everything to be measured by the

same unit

3. Store of value • Allows people postpone their purchasing

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Money Supply

The quantity of money available in the economy can be measured in many ways.

M1:Currency – paper bills and coins in the publicDemand deposits – bank account balances that

can be accessed any time by the depositor by cheque

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Bank of Canada

• Regulates the money supply in the economy

• Managed by a board of directors appointed by the Minister of Finance– Governor & Senior Deputy Governor (7 years)– 12 Directors (3 year) including MoF

• Acts as the banker to commercial banks as well as the Canadian government

• Issues currency

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Fractional Reserve Banking System

• Only a fraction of the deposits is kept as reserves based on the reserve ratio, R

• Rest is used to make loans• Creates an increase in money supply• Money Multiplier (1/R) shows how much

MS increases for every dollar in the reserve

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Open-Market Operations

*Money held by the BoC is not counted in MS

• Decease money supply by selling bonds

• Increase money supply by buying bonds

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Foreign Exchange Market Operations

• The money supply increases when the Bank of Canada buys foreign currency with Canadian currency.

• The money supply decreases when the Bank of Canada sells foreign currency for Canadian currency.

Sterilization:• Negating a change in money supply

caused by FEMO with OMO33

Overnight Rate

Bank rate – interest rate BoC charges commercial banks

Overnight rate – interest rate for short term loans between commercial banks– An increase in the overnight rate reduces the

quantity of reserves in the banking system, and therefore reduces the money supply

– A decrease in the overnight rate increases the money supply

*The minimum reserve ratio for Canadian banks is 0

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GOOD LUCK ON YOUR

MIDTERM! 35