ECON 121 Discussion: Week 8
Slides available here:
All discussion slides here:
Today’s Plan
- A Current Events Exercise
- Reviewing Long-Term Growth
- Reviewing Loanable Funds Markets
Current Events: GDP
Current Events: A Warm-Up Exercise
If you're teaching Introductory Macro, here's a useful exam question: "Based on your knowledge of how GDP is calculated, is Elon right? Explain (in up to 280 characters)." #TeachEcon
— Justin Wolfers (@justinwolfers.bsky.social) 2025-03-01T20:27:41.568Z
Also see the Associated Press article about removing \(G\) from GDP after Musk’s tweet
Long-Run Growth
Productivity and Growth
Productivity drives economic growth: when an average worker produces more
- Real GDP (output) divided by the number of workers, like GDP per capita but for workers
What increases productivity?
More physical capital for workers to use to produce output
Diminishing returns: adding more and more physical capital will have smaller positive effects on productivity
- Does having a laptop help you do homework? How about having 8 laptops?
More human capital: education and training
More technological advancements that make production more efficient
The government also plays a critical role in economic growth by building and maintaining infrastructure, investing in education and research, and protecting intellectual property rights and creating economic stability
Calculating Economic Growth
Growth rates tell us how much something (like real GDP) is growing from one period of time to another
If we assume something grows at a constant rate we can use the rule of 70 to approximate how long it will take it to double in value:
\[ \text{Doubling Time} = \frac{70}{\text{Growth Rate (%)}} \]
You can also use some simple algebra to rearrange the formula to calculate what rate something would need to grow at to double within a certain amount of time.
Example
T’Challa is committed to doubling Wakandan GDP in 10 years. What annual growth rate of GDP would Wakanda need to accomplish this?
\[ 10 = \frac{70}{\text{Growth Rate (%)}} \implies \text{Growth Rate (%)} = 7\% \]
Loanable Funds Markets
What Are Loanable Funds?
The \(I\) part of GDP is expensive: companies don’t always have the money for needed capital expenditures, construction, research, etc.
Businesses need to get money for investment spending. They usually do this by borrowing.
This is a market: there’s a demand from businesses to borrow money and a supply of this money from lenders
Can we use our demand and supply tools to analyze these markets? Yes!
- The price of borrowing money is interest
- This is how much borrowers pay to borrow money and how much suppliers make from lending money
- The demand curve still slopes downward: the lower the interest rate, the more companies will want to borrow
- The supply curve still slopes upward: the higher the interest rate, the more savers and lenders will want to lend
What Shifts The Loanable Funds Curves?
Demand curve shifters:
Changes in business opportunities
- If there are new ways for companies to make money or industries for companies to start up in, those companies will quickly need funds to invest
Changes in government borrowing
- If the government needs to borrow more money this makes loanable funds more scarce, “crowds out” private borrowers, and drives up interest rates
Supply curve shifters:
Changes in savings
- If savers save more there will be more loanable funds
Changes in net capital inflows
- How much money is flowing into and out of an economy that trades with other economies
- This is closely related to imports and exports: \(\text{NCI} = \text{IM} - \text{X}\)
Practice Problem #1
Productivity is increased by improvements/increases in four categories: labor, physical capital, human capital, and technology.
Which category does each of the below factors of productivity growth go into?
An increase in the number of college graduates
Tech companies building new data centers
New systems that allow freight train companies to transport goods more efficiently
Expanded training programs for trades workers
Practice Problem #1
Productivity is increased by improvements/increases in four categories: labor, physical capital, human capital, and technology.
Which category does each of the below factors of productivity growth go into?
An increase in the number of college graduates
Tech companies building new data centers
New systems that allow freight train companies to transport goods more efficiently
Expanded training programs for trades workers
Answer
Human capital
Physical capital
Technology
Human capital
Practice Problem #2
The equilibrium interest rates increases: would this shift the supply for loanable funds (if so, how)? Would this change the quantity supplied of loanable funds (if so, how)?
Practice Problem #2
The equilibrium interest rates increases: would this shift the supply for loanable funds (if so, how)? Would this change the quantity supplied of loanable funds (if so, how)?
Answer
The supply wouldn’t change: curve shifts change prices, not the other way around! Another way to think of this: interest rate increases don’t create more loanable funds.
Quantity supplied would increase: as interest rates increase, lenders will want to lend more, so we’ll move up (rightward) along the supply curve.
Practice Problem #3
People begin to worry about employment prospects over the next year as a recession begins. Focusing on these people, would this affect the market for loanable funds? How?
Practice Problem #3
People begin to worry about employment prospects over the next year as a recession begins. Focusing on these people, would this affect the market for loanable funds? How?
Answer
More people will begin to save more if they’re concerned they won’t have a job in the near future. This increases the supply of loanable funds.
This change in savings behavior wouldn’t affect the demand for loanable funds.
Practice Problem #4
Say the equilibrium interest rate in Country A is 2%. In Country B it’s 7%.
What would the capital flow between the two countries look like and why?
Practice Problem #4
Say the equilibrium interest rate in Country A is 2%. In Country B it’s 7%.
What would the capital flow between the two countries look like and why?
Answer
Businesses in Country B will try to borrow from savers in Country A since it’s cheaper to borrow in Country A, but there won’t be much money for them to borrow because savers in Country A will instead try to lend their money in Country B to take advantage of higher interest rates.
Capital will flow from Country A to Country B.
Practice Problem #4
Say the equilibrium interest rate in Country A is 2%. In Country B it’s 7%.
Will interest rates stay at 2% and 7%?
Practice Problem #4
Say the equilibrium interest rate in Country A is 2%. In Country B it’s 7%.
Will interest rates stay at 2% and 7%?
Answer
No. Two points:
As lenders from Country A try to lend more money in Country B, the supply curve for funds will shift right in Country B. This will drive interest rates in Country B down.
As borrowers from Country B try to borrow more money in Country A, the demand curve for funds will shift right in Country A. This will drive interest rates in Country A up.
Interest rates in both countries will eventually equalize somewhere between 2% and 7%.
Practice Problem #5
The government of Macrolasia spent more last year than it collected in tax revenue, so it must borrow to cover the difference. What’s the term for this? How does this affect the market for loanable funds? Does this affect the private sector’s (businesses’) ability to borrow?
Practice Problem #5
The government of Macrolasia spent more last year than it collected in tax revenue, so it must borrow to cover the difference. What’s the term for this? How does this affect the market for loanable funds? Does this affect the private sector’s (businesses’) ability to borrow?
Answer
A government spending more than it brings in in taxes is a budget deficit that requires borrowing to cover.
If the government needs to borrow, this pushes the demand curve for loanable funds to the right.
All else equal, this will raise the equilibrium interest rate. This can make it too expensive for some businesses to borrow, crowding out some businesses in the loanable funds market.
Practice Problem #6
The government of Macrolasia has asked you to review a few policy proposals to increase economic growth. Which policy would best drive economic growth and why?
Guarantee government takeovers of failing companies to reduce risk for entrepreneurs and business leaders
Create and fund new government agencies that provide funding to researchers at universities working on new advancements in technology, science, and health
Require companies to pay for unemployment insurance policies that cover the lost wages of any employees they lay off while those workers are between jobs
Practice Problem #6
The government of Macrolasia has asked you to review a few policy proposals to increase economic growth. Which policy would best drive economic growth and why?
Guarantee government takeovers of failing companies to reduce risk for entrepreneurs and business leaders
Create and fund new government agencies that provide funding to researchers at universities working on new advancements in technology, science, and health
Require companies to pay for unemployment insurance policies that cover the lost wages of any employees they lay off while those workers are between jobs
Answer
Proposal #2 would best drive economic growth: these agencies would subsidize research and development advancements which could be comercially beneficial (or would be too expensive for private companies to undertake).
Proposals #1 and #3 disincentivize productivity, innovation, and/or hiring and would likely harm economic growth.
