ECON102 Midterm EXAM AID Tutor: Ming Zhou

1. ECON102 Midterm EXAM AIDTutor: Ming Zhou

2. 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

3. Chapter 7 Production and Growth

4. Productivity Definition: Average output per worker OR Y/L where Y = Real GDP, L = Quantity of Labour Very important in determining the living standard for a country.

5. 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

6. 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)

7. Public Policies Y/L K/L • 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)

8. Public Policies • Encourage investment from abroad • Foreign direct investment (foreign capital) • Foreign portfolio investment (foreign money) • Beneficial to poor countries (A+) • Encourage education and training • Increases human capital (H/L+)

9. Public Policies • Establish secure property rights and maintain political stability • Gives more incentive for companies to invest in capital and technology (H/L+, A+) • Promote free trade. • Outward-oriented policies > Inward-oriented policies (A+) • Promote research and development. • Overall technology level increases (A+)

10. Population Growth • Depleting natural resources • Non-renewable resources are used up (N/L-) • Possibly encourages alternatives (A+) • Diluting the capital stock • Lower productivity due to more workers for the same amount of capital (K/L-, H/L-) • Developing new technology • More people = more intellectuals who make discoveries (A+)

11. Chapter 8 Saving, Investment, and the Financial System

12. Saving and Investment *Assuming a closed economy I = Y – C – G • Income left after consumption and government purchases are made (national savings (S)) S = I S = (Y – T – C) + (T – G) *T = amount of taxes collected – transfer payments made

13. 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

14. 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

15. 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

16. Government Policies • Saving Incentives • Lower tax on interest income will cause LFs to shift right • Investment Incentives • Tax credit on investment spending will cause LFd to shift right • Government Budget Deficits • Borrowing from the government lowers LFs available to households and firms (crowding out)

17. Chapter 9 Unemployment and its Natural Rate

18. 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

19. 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.

20. How is it measured? = 100 x Unemployment rate # of unemployed labour force labour force adult population = 100 x labour force participation rate Unemployment rate: (% of labour force that is unemployed) Labour force participation rate: (% of adult population that is in the labour force)

21. How is it measured? Problems with the measurement: • Discouraged searchers • Financial assistance • Less incentive to work • Underemployed • High education, part-time jobs

22. 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

23. 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

24. 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

25. 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

26. 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

27. Chapter 10 The Monetary System

28. Functions of Money • Medium of exchange • Something the buyer gives to the seller to purchase a good or service (eliminates double coincidence of wants) • Unit of account • Allows everything to be measured by the same unit • Store of value • Allows people postpone their purchasing power

29. Money Supply The quantity of money available in the economy can be measured in many ways. M1: Currency – paper bills and coins in the public Demand deposits – bank account balances that can be accessed any time by the depositor by cheque

30. 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

31. 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

32. 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

33. 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 OMO

34. 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

35. GOOD LUCK ON YOUR MIDTERM! 