ECONOMIC GROWTH, FINANCIAL SYSTEM AND THE BUSINESS CYCLE

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ECONOMIC GROWTH, FINANCIAL SYSTEM AND THE
BUSINESS CYCLE
PRINCIPLES OF MACROECONOMICS

• Dr. Fidel Gonzalez
• Department of Economics and Intl. Business
• Sam Houston State University

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In the long-run the only way to increase the
standard of living of the citizens of a country
is to have continuous growth in Real
GDP. Remember that real GDP measures the
production of a region using fixed prices so that
when the real GDP increases this is due to an
increase in production not in prices. In our
previous lectures we saw that production real
income. So when the real GDP increases
continuously that means that the real income of
the country is also increasing. You can see real
income as the number of goods or services
produced in the economy.
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In order to see how economic growth affects the
living standard of the residents of a country,
initially we need to consider two variables real
GDP and population. Remember that
The GDP per capita tell us what is the income per
person of a country. The real GDP per capita tell
us what is the real income per person in the
country. In the slides about GDP growth, we saw
how countries with high GDP also have a higher
human development index, better health and in
general are happier. In order to analyze what has
happened to the standard of living in a country
we use the real GDP per capital
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There are several ways to calculate the growth of
the real GDP per capita. The most common is the
obtain the percentage change between two
consecutive years.

• However, sometimes we want to talk about growth
  rates for a period of time (for example from 1980
  to 1985). There are two ways to do this
• Obtain the percentage growth year and then take
  the average of these numbers.
• Obtain the annual constant growth rate using the
  following formula

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The ACGR tells you is if the initial number
grows at a annual constant rate of ACGR it will
reach the final number in t years. When
calculating growth rates over a long period of
time this will be the preferred method. We also
want to know how big is a growth rate. In order
to do this, we use the seventy rule
An economy will double the real GDP per capita if
it grows at annual average rate of 10 during 7
years, 7 during 10 years, 5 during 14 years,
etc.
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Consider the following data for the following
countries
For Korea the initial year is 1953 and for
Germany is 1970. Calculate the ACGR for Argentina
This means that the real income per person in
Argentina grew at an average constant rate of
1. The cumulative growth for Argentina
The real income per person in Argentina increased
by 67 in 50 years.
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Sometimes we want to know how many year will it
take a country to get the real GDP per capita of
another country. This tell us how far are
countries between each other. In order to do this
we have to use logarithms and change the CAGR
equation.
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We can say the following. Given the average
annual growth of the real GDP per capita of
Mexico, how many years will it take it to reach
the same level of GDP per person as the US in
2000.
At the current average annual growth rate, it
will take Mexico 62.12 years to reach the GDP
per capita of the US in 2000. What about China?
How may year will it take China to catch-up with
the US in 2000?
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Potential GDP
When we look at the growth rate for different
countries, we want to know if the country the
level at which it is using its resources. The
potential GDP measures the GDP that would be
attained if all the firms are producing at
capacity. Producing at capacity is the
production that can be achieved when operating on
normal hours, using normal workforce. This is
not static. When population grows and the stock
of capital increases, also does the potential
GDP. Growth in potential GDP tell us how is the
production capacity of the economy growing under
normal circumstances. Growth in potential GDP is
estimated to be about 3.5 per year. However, the
actual GDP growth may be different. Usually the
economy fluctuates around the potential GDP, this
is called the Business Cycle.
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Potential GDP and the Business Cycle
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Financial System and Growth
The development of a healthy financial system is
important for growth. Remember that in the
economy we have the following types of agents
Household, Business, Government and
Foreigners. Households receive income from
working, part of the income is spent and the
other part is saved for future consumption. When
the income is saved the financial market
allocates the money to businesses that need it to
buy machinery, equipment, raw material, and so
on. In other words, savings are used to increase
the production of goods and services.
Households
Financial Institutions
Businesses
Machinery, Equipment
Consume
Save
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Financial System and Growth

• When the financial system is healthy then
  investment, production and real GDP increase.
• The financial sector provides
• Good allocation of savings specialized
  individuals evaluate firms, risks, manager and
  market conditions. Individual investor may not
  have the time or the skills to do this. When
  individuals can not evaluate all the conditions
  in the market they tend to save the money under
  the mattress because they do not like risk they
  can not measure.
• Moreover, financial intermediaries will allocate
  resources to the best opportunities and that
  increases efficiency.
• B) Improve liquidity firms investment are
  usually long or medium-term (building factories,
  buying expensive equipment, etc) and households
  do not like to have their money tied up in these
  kind of investments. The financial system creates
  equity and bonds that allows them to indirectly
  finance firms long-term projects but these
  instruments can be easily sold in the market if
  the household requires liquidity. With liquid
  financial instruments households can save and
  obtain cash relatively easily and the firms have
  access to the long-term money necessary for
  investment from the initial savers.

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Financial System and Growth
C) Monitor manager and corporate control the
financial intermediaries monitor firms to make
sure the money from the savers is used properly.
It would be very costly if every household that
lends money to a firm will have to monitor the
firm. D) Mobilize savings financial
intermediaries pool savings from different types
of households and give them a diversified
portfolio. Technological innovation is promoted
when there is money available to take measured
risks. E) Facilitating exchange the
transactions cost decreased with financial
intermediaries and households are willing to save
a little more.
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Macroeconomics of Savings and Investment
In Macroeconomics we are interested to see how an
economy saves and invest resources.
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Macroeconomics of Savings and Investment
Private Savings
Public Savings
Private savings is the amount saved by
households. Public savings is the amount saved by
the government
T-G public savings G-T government
budget Public Savings - Government Budget