1. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. Fernando & Yvonn Quijano Prepared by: Chapter 21 Economic Growth, the Financial System, and Business Cycles

2. © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 2 of 34 Growth and the Business Cycle at Boeing 21.1Discuss the importance of long- run economic growth. 21.2Discuss the role of the financial system in facilitating long-run economic growth. 21.3Explain what happens during a business cycle. Learning Objectives In this chapter, we will provide an overview of long-run growth and the business cycle and discuss their importance for individual firms, for consumers, and for the economy as a whole.

3. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 3 of 34 Economic Growth, the Financial System, and Business Cycles Business cycle Alternating periods of economic expansion and economic recession.

4. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 4 of 34 Long-Run Economic Growth Learning Objective 21.1 Long-run economic growth The process by which rising productivity increases the average standard of living. Figure 21-1 The Growth in Real GDP per Capita, 1900–2007

5. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 5 of 34 Learning Objective 21.1 The Connection between Economic Prosperity and Health Making the Connection

6. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 6 of 34 Long-Run Economic Growth Learning Objective 21.1 Calculating Growth Rates and the Rule of 70 What Determines the Rate of Long-Run Growth? Labor productivity The quantity of goods and services that can be produced by one worker or by one hour of work.

7. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 7 of 34 Long-Run Economic Growth Learning Objective 21.1 What Determines the Rate of Long-Run Growth? Capital Manufactured goods that are used to produce other goods and services. Increases in Capital per Hour Worked Technological Change Economic growth depends more on technological change than on increases in capital per hour worked. Technological change is an increase in the quantity of output firms can produce using a given quantity of inputs.

8. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 8 of 34 Solved Problem 21-1 The Role of Technological Change in Growth Learning Objective 21.1 Between 1960 and 1995, real GDP per capita in Singapore grew at an average annual rate of 6.2 percent. This very rapid growth rate results in the level of real GDP per capita doubling about every 11.5 years. In 1995, Alywn Young of the University of Chicago published an article in which he argued that Singapore’s growth depended more on increases in capital per hour worked, increases in the labor force participation rate, and the transfer of workers from agricultural to nonagricultural jobs than on technological change. If Young’s analysis was correct, predict what was likely to happen to Singapore’s growth rate in the years after 1995.

9. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 9 of 34 Learning Objective 21.1 What Explains Rapid Economic Growth in Botswana? Making the Connection

10. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 10 of 34 Long-Run Economic Growth Learning Objective 21.1 Potential Real GDP Potential GDP The level of GDP attained when all firms are producing at capacity.

11. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 11 of 34 Long-Run Economic Growth Learning Objective 21.1 Potential Real GDP FIGURE 21.2 Actual and Potential Real GDP

12. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 12 of 34 Saving, Investment, and the Financial System Learning Objective 21.2 An Overview of the Financial System Financial markets Markets where financial securities, such as stocks and bonds, are bought and sold. Financial intermediaries Firms, such as banks, mutual funds, pension funds, and insurance companies, that borrow funds from savers and lend them to borrowers. Financial system The system of financial markets and financial intermediaries through which firms acquire funds from households.

13. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 13 of 34 Saving, Investment, and the Financial System Learning Objective 21.2 The Macroeconomics of Saving and Investment Y = C + I + G + NX Y = C + I + G I = Y − C − G = Y + TR − C − T = T − G − TR

14. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 14 of 34 Learning Objective 21.2 S = (Y + TR − C − T) + (T − G − TR) S = Y − C − G S = I S = + or So, we can conclude that total saving must equal total investment: Saving, Investment, and the Financial System The Macroeconomics of Saving and Investment

15. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 15 of 34 Saving, Investment, and the Financial System Learning Objective 21.2 The Market for Loanable Funds Market for loanable funds The interaction of borrowers and lenders that determines the market interest rate and the quantity of loanable funds exchanged.

16. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 16 of 34 Learning Objective 21.2 Demand and Supply in the Loanable Funds Market FIGURE 21.3 The Market for Loanable Funds Saving, Investment, and the Financial System The Market for Loanable Funds

17. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 17 of 34 Learning Objective 21.2 Ebenezer Scrooge: Accidental Promoter of Economic Growth? Making the Connection Who was better for economic growth: Scrooge the saver or Scrooge the spender?

18. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 18 of 34 Learning Objective 21.2 Explaining Movements in Saving, Investment, and Interest Rates FIGURE 21.4 An Increase in the Demand for Loanable Funds Saving, Investment, and the Financial System The Market for Loanable Funds

19. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 19 of 34 Learning Objective 21.2 Crowding out A decline in private expenditures as a result of an increase in government purchases. Explaining Movements in Saving, Investment, and Interest Rates Saving, Investment, and the Financial System The Market for Loanable Funds

20. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 20 of 34 Learning Objective 21.2 Explaining Movements in Saving, Investment, and Interest Rates FIGURE 21.5 The Effect of a Budget Deficit on the Market for Loanable Funds Saving, Investment, and the Financial System The Market for Loanable Funds

21. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 21 of 34 Solved Problem 21-2 How Would a Consumption Tax Affect Saving, Investment, the Interest Rate, and Economic Growth? Learning Objective 21.2

22. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 22 of 34 The Business Cycle Learning Objective 21.3 FIGURE 21.6 The Business Cycle Some Basic Business Cycle Definitions

23. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 23 of 34 Learning Objective 21.3 The Business Cycle and the 2008 Election Making the Connection The state of the U.S. economy was one factor that helped Barack Obama win the presidency in 2008. The National Bureau of Economic Research (NBER) has the following broader definition: “A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.” There is substantial evidence that in some elections, the state of the economy can be of decisive importance. As real GDP began to decline and unemployment began to rise, Barack Obama ultimately won the election by a margin in the popular vote of 52 percent to 46 percent.

24. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 24 of 34 The Business Cycle Learning Objective 21.3 What Happens during a Business Cycle? The Effect of the Business Cycle on Boeing Figure 21-7 The Effect of the Business Cycle on Boeing

25. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 25 of 34 Learning Objective 21.3 FIGURE 21.8 The Effect of the 2001 Recession on the Inflation Rate The Effect of the Business Cycle on the Inflation Rate The Business Cycle What Happens during a Business Cycle?

26. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 26 of 34 Learning Objective 21.3 FIGURE 21.9 The Impact of Recessions on the Inflation Rate The Effect of the Business Cycle on the Inflation Rate Don’t Let This Happen to YOU! Don’t Confuse the Price Level and the Inflation Rate The Business Cycle What Happens during a Business Cycle?

27. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 27 of 34 Learning Objective 21.3 FIGURE 21.10 How the Recession of 2001 Affected the Unemployment Rate The Effect of the Business Cycle on the Unemployment Rate The Business Cycle What Happens during a Business Cycle?

28. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 28 of 34 Learning Objective 21.3 FIGURE 21.11 The Impact of Recessions on the Unemployment Rate The Effect of the Business Cycle on the Unemployment Rate The Business Cycle What Happens during a Business Cycle?

29. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 29 of 34 Learning Objective 21.3 Recessions Have Been Milder and the Economy Has Been More Stable Since 1950 The Business Cycle What Happens during a Business Cycle? FIGURE 21.12 Fluctuations in Real GDP, 1900–2007

30. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 30 of 34 Learning Objective 21.3 Recessions Have Been Milder and the Economy Has Been More Stable Since 1950 Table 21-1 The Business Cycle Has Become Milder PERIOD AVERAGE LENGTH OF EXPANSIONS AVERAGE LENGTH OF RECESSIONS 1870-190026 months 1900-195025 months19 months 1950-200161 months9 months The Business Cycle What Happens during a Business Cycle?

31. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 31 of 34 Learning Objective 21.3 The increasing importance of services and the declining importance of goods. The establishment of unemployment insurance and other government transfer programs that provide funds to the unemployed. Active federal government policies to stabilize the economy. The Business Cycle Why Is the Economy More Stable?

32. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 32 of 34 An Inside LOOK China’s Airlines Are Failing to Translate Rapid Growth into Profits Chinese Aviation: On a Wing and a Prayer

33. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 33 of 34 An Inside LOOK China’s Airlines Are Failing to Translate Rapid Growth into Profits Chinese Aviation: On a Wing and a Prayer (continued)

34. Chapter 21: Economic Growth, the Financial System, and Business Cycles © 2009 Prentice Hall Business Publishing Economics Hubbard/O’Brien UPDATE EDITION. 34 of 34 Business cycle Capital Crowding out Financial intermediaries Financial markets Financial system Labor productivity Long-run economic growth Market for loanable funds Potential GDP K e y T e r m s