02. - Aggregate Incomes

Question 1

There are very large differences across countries in GDP per capita. We can compare income differences across countries using…..

Answer 1

….. GDP per capita at current exchange raes or adjusted for differences in purchasing power parity

Question 2

The aggregate production function links a country´s GDP to….

Answer 2

…. its capital stock, its total efficiency units of labor, and its technology

Question 3

To measure how wealthy an economc is, we use…..

Answer 3

…. income per capita
= GDP per capita = GDP / Total population

Question 4

What are the two main methods used to compare GDP per capita across countries?

Answer 4

• exchange rate adjustment
• purchasing power parity adjustment

Question 5

What is the formula to convert local GDP per capita into US dollars?

Answer 5

GDP per capita in US dollars =
GDP per capita in local currency * currency exchange rate in $ per unit of local currency

e.g. GDP per capita in china in $ = 43,636 yuan * 0.161 $/yuan = $7,033

Question 6

What are challenges when simply using the exchange rate adjustment?

1.
2.

Answer 6

• prices of goods and services can vary across economies since cost of living differ
• exchange rate fluctuates throughout the year not only due to price changes, but also due to other reasons (i.e. exchange rates are no ideal measures for differences in cost of living)

Question 7

What is the Purchasing Power Parity (PPP) adjustment based on?

1.
2.

Answer 7

• idetifying the cost of a representative basket of goods in each country
• using the ratio of these costs for comparing income across countries

i.e. GDP per capita = GDP per capita in local currency * PPP adjustment ratio

Question 8

Pros and Cons of using the bigmac for PPP adjustment?

Answer 8

• very simple (to collect data)
• available in over 31,000 restaurants in over 119 countries
• only small fraction of peoples consumption
• not only reflects price level of a country, but is also individually influenced by many other factors

Question 9

What is the main reason why GDP per capita differs across countries? And why?

Answer 9

• productivity
• Human capital, physcial capital (including land); technology

Question 10

What is productivity?

Answer 10

• refers to the value of goods and services that a worker generates per hour

Question 11

What is human capital?

1.
2
3.

Answer 11

• each persons stock of skills to produce output or economic value
• total efficiency units of labor (H) refer to the product of the average human capital (or efficiency) of workers (h) and the number of workers (L): H = h * L
• can be increased by employing more workers or by raising their human capital

Question 12

What is physical capital (stock)?

1.
2.
3.
4.

Answer 12

• any good, including machines, software etc. used for production
• physical capital stock of an economy is the value of equipment, structures and other non-labort inputs used in production
• often in economic models, land and natural resources are also included in physical capital
• denoted by K

Question 13

What is technology?

1.
2.

Answer 13

• is a set of devices and practices that determine how efficiently an ecnonomy uses its labor and capital
• denoted by A

Question 14

What is the Aggregate Production Function? (APF)

Answer 14

• describes the relationship between the aggregate GDP of a nation and its factors of production
• Y = A * F (K,H)
• where Y is GDP and F is a function of K and H

Question 15

What is meant by the positive first partial derivative?

Answer 15

• Y is increasing in H and K, i.e. holding one factor constant, Y will increase in the other

Question 16

What is the Law of Diminishing Marginal Product?

1.
2.

Answer 16

• holding one factor constant, the marginal contribution to GDP of the factor dominishes when the increase its quantity
• negative second partial derivative

Question 17

What are the different compontents of technology?

1.
2.

Answer 17

• its advances can be reflected in knowledge ragrding the production factors (e.g. computers are now part of K or programming abilities part of h)
• its advances can improve the efficiency of production, i.e. the ability to produce the maximum output from a given amount of production factors and knowledge (ex. organizing the economy as a market economy may generate higher output than organizing it as a centrally planned economy)

Question 18

What are different channels that impact technology?

1.
2.
3.

Answer 18

• entrepreneurship
• market structure (e.g. lack or presence of competition)
• spending on R&D

Question 19

What is the Cobb Douglas function?

Answer 19

• special form of APF
• exponents K and H sum to 1, so it has constant returns to scale (doubling both inputs = doubling both outputs)
• it fits real world data: reflects the empirically rather constant payments to production factors