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Section 7: Economic Growth and Productivity
Although short, this section stresses the importance of long-run economic growth. It examines the
determinants of growth and government policies to promote economic growth
1. Define
economic
growth and
list the
factors
that
stimulate
growth.
2. Assess the
role of
productivit
y in raising
real output
and
standard of
living.
Economic Growth…
 An economy’s productive capacity, potential output, or potential GDP
 Set by the quantity and quality of resources and the state of technology
 Graphically shown by the production possibilities curve
 Is fixed in the short term but can occur in the long run when resource and
technology and improved
The determinants of productive capacity include…
 Human resources – “investment” in human capital (education and skill
levels)
 Natural resources
 Investment in capital goods
 Technological progress
 Public policy – taxes, infrastructure, property rights which can either
impede or encourage efficient markets and entrepreneurial endeavors =>
increased spending of C + I + G
Growth of real GDP per capita occurs only when the rate of productivity (real
output per worker) increases.
Check for understanding:
http://www.quia.com/quiz/5039870.html?AP_rand=1052535132
3. Suggest
how public
policies
stimulate
economic
growth.
Expansionary => Shift
AD to the right
*Increased investment
in human and human
resources can lead to
economic growth.
Contractionary =>
Shift AD to the right
Monetary Policy
Increase money supply:
1) Open-market
operations: buy
bonds
2) Decrease reserve
requirement
3) Decrease
discount rate
Fiscal Policy
1) Increase
government
spending
2) Decrease taxes
Decrease MS:
1) OMO: sell bonds
2) Increase res. req.
3) Increase dis. Rate
4) Decrease G
5) Decrease T
4. Using
graphical
and tabular
analysis,
show the
benefit of
employing
comparativ
e
advantage.
A description of comparative advantage: Library of Economics and Liberty
Practice problem: http://www.quia.com/quiz/5039891.html (same as below, but
with answers)
Section 8: Open Economy: International Trade and Finance
This section of the course stresses the effect of world trade, capital flows, and the determination of
foreign exchange rates.
5. Explain
how the
balance of
payments
accounts
are
recorded.
Helpful reading: International Finance and the BOP
6. Explain the
effect of
trade
restrictions
.
The effects of free trade can be determined by comparing the domestic price
without trade to the world price. A low domestic price indicates that the country
has a comparative advantage in producing the good and that the country will
become an exporter. A high domestic price indicates that the rest of the world has
a comparative advantage in producing the good and that the country will become
an importer.
When a country allows trade and becomes an exporter of a good, producers of the
good are better off, and consumers of the good are worse off. When a country
allows trade and becomes an importer of a good, consumers are better off, and
producers are worse off. In both cases, the gains from trade exceed the losses.
A tariff—a tax on imports—moves a market closer to the equilibrium that would
exist without trade and, therefore, reduces the gains from trade. Although
domestic producers are better off and the government raises revenue, the losses to
consumers exceed these gains
There are various arguments for restricting trade: protecting jobs, defending
national security, helping infant industries, preventing unfair competition, and
responding to foreign trade restrictions. Although some of these arguments have
some merit in some cases, economists believe that free trade is usually the better
policy.
7. List the
factors
that
influence
equilibrium
foreign
exchange
rates.
Fiscal

8. Using
demand/su
pply
analysis,
show how
market
forces and
public
policy
affect
currency
demand
and
currency
supply.
Flexible exchange-rate system: rates at which national currencies are exchanged for
one another are determined by demand and supply and in which no government
intervention occurs.
Expansionary policy => higher domestic interest rate => increased foreign
demand for dollars => dollar appreciates => net exports decline => balance
of trade becomes less “favorable”
 Contractionary policy => lower domestic interest rate => decreased
foreign demand for dollars => dollar depreciates => net exports increase =>
balance of trade becomes more “favorable”
Monetary
 Easy money policy => decreased foreign demand for dollars => dollar
depreciates => net exports increase => balance of trade becomes more
“favorable”
 Tight money policy => increased foreign demand for dollars => dollar
appreciates => net exports decrease => balance of trade becomes less
“favorable”
Fixed exchange-rate system: governments determine rates at which currencies are
exchanged and make necessary adjustments in their economies to ensure that
these rates continue
9. Define
currency
appreciatio
n and
depreciatio
n and
relate both
to
graphical
analysis.
10. State the
effects of
appreciatio
n and
depreciatio
n on a
country’s
net
exports.
11. Understan
d how
changes in
net exports
and capital


If exports exceed imports, you get a trade surplus which is considered a
“favorable balance of trade”. If imports exceed exports, you get a trade deficit
which is considered an “unfavorable balance of trade”.
A “favorable” balance of trade is not entirely good, however. We cannot buy as
much foreign goods now (since our dollar is worth less) so foreign companies
flows
affect
financial
and goods
markets.

don’t get as much business from us. However, when foreign prices rise,
Americans turn to American companies to buy things from, helping American
companies make more money.
Likewise, an “unfavorable” balance of trade isn’t entirely bad either. Since our
dollar has grown in value, we can buy more foreign goods, so foreign
companies get more money. However, because of cheaper foreign goods,
American companies won’t get as much business (or they have to lower prices),
so they don’t get as much money.