Activity 7 - Reflection &Discussion Assigned Readings: BOOK: Title: Economics for Investment Decision Makers: Micro, Macro, and International Economics

ISBN: 978-1-118-10536-8

Authors: Christopher D. Piros, Jerald E. Pinto, Larry Harris (Foreword by)

Publisher: John Wiley & Sons

Chapter 11 Economic Growth and the Investment Decision Chapter 12 Economics of Regulation Initial Postings: Read and reflect on the assigned readings for the week. Then post what you thought was the most important concept(s), method(s), term(s), and/or any other thing that you felt was worthy of your understanding in each assigned textbook chapter. Your initial post should be based upon the assigned reading for the week, so the textbook should be a source listed in your reference section and cited within the body of the text. Other sources are not required but feel free to use them if they aid in your discussion.

Chapter 11 Economic Growth and the Investment Decision

The following points, among others, are made in this chapter:

• The sustainable rate of economic growth is measured by the rate of increase in the economy's productive capacity or potential GDP.
• Growth in real GDP measures how rapidly the total economy is expanding. Per capita
• GDP, defined as real GDP divided by population, measures the standard of living in each country.
• The growth rate of real GDP and the level of per capita real GDP vary widely among countries. As a result, investment opportunities differ by country.
• Equity markets respond to anticipated growth in earnings. Higher sustainable economic growth should lead to higher earnings growth and equity market valuation ratios, all other things being equal.
• The best estimate for the long-term growth in earnings for a given country is the estimate of the growth rate in potential GDP.
• In the long run, the growth rate of earnings cannot exceed the growth in potential GDP. Labor productivity is critical because it affects the level of the upper limit. A permanent increase in productivity growth will raise the upper limit on earnings growth and should translate into faster long-run earnings growth and a corresponding increase in stock price appreciation.
• For global fixed-income investors, a critical macroeconomic variable is the rate of inflation. One of the best indicators of short- to intermediate-term inflation trends is the difference between the growth rate of actual and potential GDP.
• Capital deepening, an increase in the capital-to-labor ratio, occurs when the growth rate of capital (net investment) exceeds the growth rate of labor. In a graph of output per capita versus the capital-to-labor ratio, it is reflected by a move along the curve (i.e., the production function).
• An increase in total factor productivity (TFP) causes a proportional upward shift in the entire production function.
• One method of measuring sustainable growth uses the production function and the growth accounting framework developed by Solow. It arrives at the growth rate of potential GDP by estimating the growth rates of the economy's capital and labor inputs plus an estimate of total factor productivity.
• An alternative method measures potential growth as the long-term growth rate of the labor force plus the long-term growth rate of labor productivity.
• The forces driving economic growth include the quantity and quality of labor and the supply of non-ICT and ICT capital, public capital, raw materials, and technological knowledge.
• The labor supply is determined by population growth, the labor force participation rate, and net immigration. The physical capital stock in a country increases with net investment. The correlation between long-run economic growth and the rate of investment is high.
• Technological advances are discoveries that make it possible to produce more or higher quality goods and services with the same resources or inputs. Technology is a major factor determining TFP. TFP is the main factor affecting long-term, sustainable economic growth rates in developed countries and also includes the cumulative effects of scientific advances, applied research and development, improvements in management methods, and ways of organizing production that raise the productive capacity of factories and offices.
• Total factor productivity, estimated using a growth accounting equation, is the residual component of growth once the weighted contributions of all explicit factors (e.g., labor and capital) are accounted for.
• Labor productivity is defined as output per worker or per hour worked. Growth in labor productivity depends on capital deepening and technological progress.
• The academic growth literature is divided into three theoriesthe classical view, the neoclassical model, and the new endogenous growth view.
• In the classical model, growth in per capita income is only temporary because an exploding population with limited resources brings per capita income growth to an end.
• In the neoclassical model, a sustained increase in investment increases the economy's growth rate only in the short run. Capital is subject to diminishing marginal returns, so long-run growth depends solely on population growth, progress in TFP, and labor's share of income.
• The neoclassical model assumes that the production function exhibits diminishing marginal productivity with respect to any individual input.
• The point at which capital per worker and output per worker are growing at equal, sustainable rates is called the steady state or balanced growth path for the economy. In the steady state, total output grows at the rate of labor force growth plus the rate of growth of TFP divided by the elasticity of output with respect to labor input.
• The following parameters affect the steady state values for the capital-to-labor ratio and output per worker: saving rate, labor force growth, growth in TFP, depreciation rate, and elasticity of output with respect to capital.
• The main criticism of the neoclassical model is that it provides no quantifiable prediction of the rate or form of TFP change. TFP progress is regarded as exogenous to the model.
• Endogenous growth theory explains technological progress within the model rather than treating it as exogenous. As a result, self-sustaining growth emerges as a natural consequence of the model and the economy does not converge to a steady state rate of growth that is independent of saving/investment decisions.
• Unlike the neoclassical model, where increasing capital will result in diminishing marginal returns, the endogenous growth model allows for the possibility of constant or even increasing returns to capital in the aggregate economy.
• In the endogenous growth model, expenditures made on R&D and for human capital may have large positive externalities or spillover effects. Private spending by companies on knowledge capital generates benefits to the economy as a whole that exceed the private benefit to the company.
• The convergence hypothesis predicts that the rates of growth of productivity and GDP should be higher in the developing countries. Those higher growth rates imply that the per capita GDP gap between developing and developed economies should narrow over time. The evidence on convergence is mixed.
• Countries fail to converge because of low rates of investment and savings, lack of property rights, political instability, poor education and health, restrictions on trade, and tax and regulatory policies that discourage work and investing.
• Opening an economy to financial and trade flows has a major impact on economic growth. The evidence suggests that more open and trade-oriented economies will grow at a faster rate

Chapter 12 Economics of Regulation

This chapter makes the following points, among others:

• Legislative bodies, regulatory bodies, and courts typically enact regulation.
• Regulatory bodies include government agencies and independent regulators granted authority by a government or governmental agency. Some independent regulators may be self-regulating organizations.
• Typically, legislative bodies enact broad laws or statutes; regulatory bodies issue administrative regulations, often implementing statutes; and courts interpret statutes and administrative regulations, and these interpretations may result in judicial law.
• Regulators have responsibility for both substantive and procedural laws. The former focuses on rights and responsibilities of entities and relationships among entities. The latter focuses on the protection and enforcement of the former.
• The existence of informational frictions and externalities creates a need for regulation. Regulation is expected to have societal benefits and should be assessed using cost-benefit analysis.
• Regulation that arises to enhance the interests of regulated entities reflects regulatory capture.
• Regulatory competition is competition among different regulatory bodies to use regulation in order to attract certain entities.
• Regulatory arbitrage is the use of regulation by an entity to exploit differences in economic substance and regulatory interpretation or in regulatory regimes to the entity's benefit.
• Interdependence in the actions and potentially conflicting objectives of regulators is an important consideration for regulators, those regulated, and those assessing the effects of regulation.
• There are many regulatory tools available to regulators, including price mechanisms (such as taxes and subsidies), regulatory mandates and restrictions on behaviors, provision of public goods, and public financing of private projects.
• The choice of regulatory tool should be consistent with maintaining a stable regulatory environment. Stable does not mean unchanging, but rather refers to desirable attributes of regulation, including predictability, effectiveness in achieving objectives, time consistency, and enforceability.
• The breadth of regulation of commerce necessitates the use of a framework that identifies potential areas of regulation. This framework can be referenced to identify specific areas of regulation, existing and anticipated, that may affect the entity of interest.
• The regulation of securities markets and financial institutions is extensive and complex because of the consequences of failures in the financial system. These consequences include financial losses, loss of confidence, and disruption of commerce.
• The focus of regulators in financial markets includes prudential supervision, financial stability, market integrity, and economic growth, among others.
• Regulatorsin assessing regulation and regulatory outcomesshould conduct ongoing cost-benefit analyses, develop techniques to enhance the measurement of these analyses, and use economic principles for guidance.
• Net regulatory burden to the entity of interest is an important consideration for an analyst.