Economics 101: Principles of Economics 1.Questions?

Consumer Price Index Is the CPI a good measure of changes in cost of living? 1. Substitution bias Causes CPI to overstate or understate? 2. New goods 3. Quality 4. Growth in Discount purchasing Correcting for the effects of inflation Babe Ruth’s salary today? What do we need to know? COLA’s Real vs. Nominal interest rates

Production and Growth Level of real GDP is good indicator of standard of living and the growth rate of real GDP is good indicator of economic progress International comparisons Average growth rates are just that, averages. Growth rates imply that the rankings can change dramatically over time. What determines the level and growth of real GDP? Principle #8: A Country’s Standard of Living depends on its Ability to Produce Goods & Services –Public policy must ask itself, “How can we  productivity?” Productivity = quantity of g & s a worker can produce per hour worked Okay, what determines productivity? Let’s build decks. Physical capital, Human capital, Natural resources Big beneficiaries? Limited supply – is it a problem? Technological knowledge/understanding Production function Y = A f(K, L, H, N) … Y/L depends on

Economic Growth & Public Policy How can a government help raise productivity ? Invest in production of capital Trade-off -- more investment means less consumption today Reverse causation? Investment  Growth, or vice versa, or 3rd var. Diminishing returns to capital Implies that higher savings  growth of Y and productivity only temporarily Catch-up effect: poorer start can mean faster growth Investment in capital by foreigners Foreign Direct Investment (FDI) is capital investment owned & operated by a foreign firm Foreign Portfolio Investment (FPI) is capital investment that is owned by foreigners, but operated by domestic persons Investment in human capital Motivation is in part positive externalities from education

Economic Growth & Public Policy How can a government help raise productivity ? Protect property rights Effective judicial and legal system throughout the country Corruption Index Promote free trade Geography Major trade centers are located on waterways Limit population growth GDP per person is most important More people  harder to keep up capital stock (human & physical) Explicit – China Implicitly – increase awareness of birth control increase opportunities for women Promote Research & Development Inventions improve productivity, so promote them via NSF/NIH, patents, tax breaks