1. c h a p t e r twenty-one © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. Prepared by: Fernando & Yvonn Quijano Economic Growth, the Financial System, and Business Cycles

2. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 2 of 29 After studying this chapter, you should be able to: Discuss the importance of long-run economic growth. Discuss the role of the financial system in facilitating long-run economic growth. Explain what happens during a business cycle. Growth and the Business Cycle at the Ford Motor Company LEARNING OBJECTIVES 1 2 3 In this chapter we will look more closely at long-run growth and at the business cycle, both of which have had important implications for individual firms and for the economy as a whole.

3. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 3 of 29 Economic Growth, the Financial System, and Business Cycles Business cycle Alternating periods of economic expansion and economic recession.

4. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 4 of 29 Long-Run Economic Growth Is the Key to Rising Living Standards LEARNING OBJECTIVE 1 21 - 1 The Growth in Real GDP per capita, 1900-2004 Long-run economic growth The process by which rising productivity increases the average standard of living.

5. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 5 of 29 The Connection Between Economic Prosperity and Health 21 - 1 Because of technological advance, these children will live longer, be healthier, and work less than their parents and grandparents.

6. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 6 of 29 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. INCREASES IN CAPITAL PER HOUR WORKED Capital Manufactured goods that are used to produce other goods and services; examples of capital are computers, factory buildings, machine tools, warehouses, and trucks. Long-Run Economic Growth Is the Key to Rising Living Standards

7. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 7 of 29 21-1 Long-Run Economic Growth Is the Key to Rising Living Standards What Determines the Rate of Long-Run Growth? INCREASES IN CAPITAL PER HOUR WORKED Human capital The accumulated knowledge and skills that workers acquire from education and training, or from their life experiences. TECHNOLOGICAL CHANGE The Role of Technological Change in Growth LEARNING OBJECTIVE 1

8. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 8 of 29 What Explains Rapid Economic Growth in Botswana? 21 - 2 Firms like the Botswana Meat Company benefit from government policies that protect private property.

9. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 9 of 29 Long-Run Economic Growth Is the Key to Rising Living Standards Potential Real GDP Potential GDP The level of GDP attained when all firms are producing at capacity. 21 - 2 Actual and Potential Real GDP

10. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 10 of 29 Saving, Investment, and the Financial System LEARNING OBJECTIVE 2 Financial system The system of financial markets and financial intermediaries through which firms acquire funds from households. An Overview of the Financial System

11. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 11 of 29 Saving, Investment, and the Financial System The Macroeconomics of Saving and Investment

12. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 12 of 29 Saving, Investment, and the Financial System 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. THE DEMAND AND SUPPLY IN THE LOANABLE FUNDS MARKET

13. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 13 of 29 Saving, Investment, and the Financial System The Market for Loanable Funds 21- 3 The Market for Loanable Funds

14. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 14 of 29 Ebenezer Scrooge: Accidental Promoter of Economic Growth? 21 - 3 Who was better for economic growth: Scrooge the saver, or Scrooge the spender?

15. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 15 of 29 Saving, Investment, and the Financial System The Market for Loanable Funds EXPLAINING MOVEMENTS IN SAVING, INVESTMENT, AND INTEREST RATES 21 - 4 An Increase in the Demand for Loanable Funds

16. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 16 of 29 Saving, Investment, and the Financial System The Market for Loanable Funds EXPLAINING MOVEMENTS IN SAVING, INVESTMENT, AND INTEREST RATES 21 - 5 The Effect of a Budget Deficit on the Market for Loanable Funds

17. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 17 of 29 How Would a Consumption Tax Affect Saving, Investment, the Interest Rate, and Economic Growth? 21-2 LEARNING OBJECTIVE 2

18. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 18 of 29 The Business Cycle LEARNING OBJECTIVE 3 21 - 6 Movements in Real GDP, 1998-2004 Some Basic Business Cycle Definitions

19. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 19 of 29 Who Decides If the Economy Is In a Recession? 21 - 4 The National Bureau of Economic Research determines when recessions begin and end. PEAKTROUGH LENGTH OF RECESSION July 1953May 195410 months August 1957April 19588 months April 1960February 196110 months December 1969November 197011 months November 1973March 197516 months January 1980July 19806 months July 1981November 198216 months July 1990March 19918 months March 2001November 20018 months

20. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 20 of 29 The Business Cycle 21 - 7 The Effect of the Business Cycle on Automobile Production What Happens During a Business Cycle? THE EFFECT OF THE BUSINESS CYCLE ON AUTOMOBILE PRODUCTION

21. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 21 of 29 The Business Cycle 21 - 8 The Effect of the 2001 Recession on the Inflation Rate What Happens During a Business Cycle? THE EFFECT OF THE BUSINESS CYCLE ON THE INFLATION RATE Don’t Confuse the Price Level and the Inflation Rate

22. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 22 of 29 The Business Cycle 21 - 9 The Impact of Recessions on the Inflation Rate What Happens During a Business Cycle? THE EFFECT OF THE BUSINESS CYCLE ON THE UNEMPLOYMENT RATE

23. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 23 of 29 The Business Cycle 21 - 10 How the Recession of 2001 Affected the Unemployment Rate What Happens During a Business Cycle? THE EFFECT OF THE BUSINESS CYCLE ON THE UNEMPLOYMENT RATE

24. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 24 of 29 The Business Cycle 21 - 11 The Impact of Recessions on the Unemployment Rate What Happens During a Business Cycle? RECESSIONS HAVE BEEN MILDER AND THE ECONOMY HAS BEEN MORE STABLE SINCE 1950

25. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 25 of 29 The Business Cycle 21 - 12 Fluctuations in Real GDP, 1900-2004 What Happens During a Business Cycle? RECESSIONS HAVE BEEN MILDER AND THE ECONOMY HAS BEEN MORE STABLE SINCE 1950

26. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 26 of 29 The Business Cycle What Happens During a Business Cycle? RECESSIONS HAVE BEEN MILDER AND THE ECONOMY HAS BEEN MORE STABLE SINCE 1950 The Business Cycle Has Become Milder 21 – 1 PERIOD AVERAGE LENGTH OF EXPANSIONS AVERAGE LENGTH OF RECESSIONS 1870-190026 months 1900-195025 months19 months 1950-200161 months9 months

27. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 27 of 29 The Business Cycle Why Is the Economy More Stable?  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.

28. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 28 of 29 Here Come Chinese Cars

29. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 21: Economic Growth, the Financial System, and Business Cycles 29 of 29 Business cycle Capital Financial system Human capital Labor productivity Long-run economic growth Market for loanable funds Potential GDP