Production and Growth
• A country’s standard of living depends on its ability to produce goods and services.
•
• ProductivityProductivity refers to the amount of goods and services produced for each hour of a worker’s time.
• A nation’s standard of living is determined by the productivity of its workers.
• Annual growth rates that seem small become large when compounded for many years. (recall: the Rule of 72)
• The Factors of Production affecting productivity include: – Physical capital – tools, machines, equipment
– Human capital – training, knowledge, experience – Natural resources – raw materials drown from nature
Economic Growth and Public Policy
• Governments can do many things to raise productivity and living standards.
• Government Policies that raise Productivity and Living Standards – Encourage saving and investment.
– Encourage investment from abroad – Encourage education and training.
– Establish secure property rights and maintain political stability. – Promote free trade.
Summary
• Economic prosperity, as measured by real GDP per person, varies substantially around the world.
• The average income of the world’s richest countries is more than ten times that in the world’s poorest countries.
• The standard of living in an economy depends on the economy’s ability to produce goods and services.
• Productivity depends on the amounts of physical capital, human capital, natural resources, and technological knowledge available to workers.
• Government policies can influence the economy’s growth rate in many different ways.
• Higher saving and investment leads to a higher growth.
Barriers to Trade
– A Tariff is a tax (duty) imposed on imported goods.
A tariff on imported goods makes them more expensive to domestic consumers. Tariffs raise domestic prices and reduce quantity sold. It makes them less competitive with domestically produced goods.
– A Quota is a limit on the quantity of a good that may be imported. By limiting sales of imported goods, they give domestic producers opportunity to raise market price.
Interdependence and the Gains from Trade
• How do we satisfy our wants and needs in a global economy?
• Self-Sufficiency
• By ignoring each other:
– Each consumes what they each produce.
– The production possibilities frontier is also the consumption possibilities frontier. – Without trade, economic gains are diminished.
– Enforced by Barriers to Trade like tariffs and quotas.
COMPARATIVE ADVANTAGE
states that nations should produce and export goods and services for which they have the least opportunity cost
• Differences in the costs of production determine the following: – Who should produce what?
– How much should be traded for each product?
• Differences in Costs of Production:
• The number of hours required to produce a unit of output • The opportunity cost of sacrificing one good for another.
• Each person consumes goods and services produced by many other people both in our country and around the world.
• Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services.
Closed vs. Open Economies
• Open and Closed Economies
– A closed economy is one that does not interact with other economies in the world.
• There are no exports, no imports, and no capital flows.
• This is usually enforced through barriers to trade like quotas and tariffs.
Open-Economies
• An Open Economy interacts with other countries in two ways.
• It buys and sells goods and services in world product markets. • It buys and sells capital assets in world financial markets.
– The United States is a very large and open economy—it imports and exports huge quantities of goods and services.
The Internationalization of the U.S. Economy
Percent
of GDP
0
5
10
15
1950 1955 1960 1965 1970 1975 1980
1985
1990
1995
2000
Exports
Imports
Exports, Imports, Net Exports
• Exports are goods and services that are produced domestically and sold abroad.
• Imports are goods and services that are produced abroad and sold domestically.
• Net exports (NX) are the value of a nation’s exports minus the value of its imports.
• A trade deficit is a situation in which net exports (NX) are negative. Imports > Exports
• A trade surplus is a situation in which net exports (NX) are positive. Exports > Imports
• Balanced trade refers to when net exports are zero—exports and imports are equal. Imports = Exports
Net Exports
• Factors That Affect Net Exports
– The tastes of consumers for domestic and foreign goods.
– The prices of goods at home and abroad.
– The exchange rates at which people can use domestic currency to buy foreign currencies.
Nominal Exchange Rates
• An Exchange Rate is the price of one currency expressed in terms of another currency
• Exchange Rates are expressed in two ways:
– In units of foreign currency per one U.S. dollar.
– And in units of U.S. dollars per one unit of the foreign currency.
EX.
Assume the exchange rate between the Japanese yen and U.S. dollar is 80 yen to one dollar.
– One U.S. dollar trades for 80 yen.
Exchange Rates
An exchange rate measures the value of one currency in units of another currency
• Every trade will require two different currencies as long as each nation has its own currency.
• The cost of a good depends on:
Price of Imported Good = Price of Foreign Good x Price of Foreign Currency
EX.
Assuming a dollar is worth 2 euros, and an American wanted to buy a 20 euro bottle of French wine, thenI
The Euro Market
Euros demanded by:
-U.S. travelers to Europe U.S. consumers buying -European exports
-U.S. investors in European markets
Euros supplied by:
-European consumers -European travelers
-European investors in U.S. markets
QUANTITY OF EUROS (euros per year)
Nominal Exchange Rates
• Appreciation refers to an increase in the value of a currency as measured by the amount of foreign currency it can buy.
EX. If a dollar buys more foreign currency, there is an appreciation of the dollar.
• Depreciation refers to a decrease in the value of a currency as measured by the amount of foreign currency it can buy.
EX. If the dollar buys less foreign currency, there is a depreciation of the dollar.
Note:
These relationships are reciprocal.
Thus, when the dollar buys more foreign currency, the foreign currency buys less dollars. And when the dollar buys less foreign currency, the foreign currency buys more dollars.
Currency Appreciation
E
1E
2An increase in euro demand causes it to appreciate.
