9/10 - Economic Growth

Question 1

What is the production function?

Answer 1

Y_t = F(N_t,X_t)

Question 2

What happens if labour and other inputs double to production?

Answer 2

Output doubles.

2Y_t=F(2N_t,2X_t)

Question 3

What does the CRS of the production function mean?

Answer 3

δY/δN = MPN > 0 (every added worker causes output to increase)

δ²Y/δN² < 0 (rate of increase of output per worker falls)

Question 4

What was the Malthusian mechanism for suggesting people couldn’t escape subsistence income?

Answer 4

Increases in income per capita increase fertility (more food, more children)
Assume land is fixed (probably correct)
Therefore dimininishing marginal returns to labour
Income per capita falls with population

Question 5

Was Malthus correct?

Answer 5

Up until the industrial revolution, probably.

Question 6

Draw the Malthusian mechanism.

Answer 6

Question 7

Why do we shift from f₀N to f₁N?

Answer 7

Improvement in technology.

Question 8

Why do we shift back down the f₁N line?

Answer 8

The MPN falls per worker, causing income per worker to return back to s (subsistence income)

Question 9

Differentiate the agricultural production function to prove MPN is positive.

Answer 9

Y = N^αL^1-α

MPN = αN^α-1L^1-α
= α(L/N)^1-α

L/N is positive, α is positive, therefore MPN is positive.

Question 10

Show algebraically how we escaped the Malthusian trap.

Answer 10

Agricultural production function changed to an industrial production function.

Y = N^αK^1-α
MPN = α(L/K)^1-α

Capital, K, can be increased, whereas land, L, is fixed so population growth does not mean that living standards fall iff it occurs in an environment of capital intensive production.

Question 11

Why did we move from an agricultural production method to capital production method?

Answer 11

• Institutional reasons (constrained power, culture of knowledge)
• Historical accident (stability / instability of different societies)

Question 12

How does the view of constrained power cause a move from an agricultural production method to capital production method?

Answer 12

1688 - Glorious Revolution in UK

Parliamentary rights to control laws of taxation AND issue of royal debt removed a major threat to personal property causing:

• interest rates on royal debt to fall massively increasing the incentive to invest
• reducing OC of investing in private sector

Question 13

How does the view of culture of knowledge cause a move from an agricultural production method to capital production method?

Answer 13

New ideas are vital for new technologies. Learning to read the Bible causes literacy rates to increase, causing people to read about new technologies.

Sharing of ideas between scientists and literate entrepreneurs allows new technologies to improve living standards.

Question 14

How does the view of historical accident cause a move from an agricultural production method to capital production method?

Answer 14

War, pestilence and plague caused the labour force to fall massively, increasing the real wage per worker.

As a result, people have an incentive to invest in more capital and energy intensive production methods.

Question 15

Sketch Allen’s model and describe what it shows.

Answer 15

To produce Q₁, you can either do with with high capital K_H and L_L or L_H and K_L.

Countries with relatively high costs of labour (i.e. Europe) choose the higher K as wages are much greater than interest rates, whereas countries with relatively low costs of labour (i.e. the East) choose lower K as wages are closer (or less than) interest rates.

Question 16

Sketch Allen’s model with an improvement to technology.

Answer 16

New tech trades off capital and labour at different rates (i.e. more capital intensive).

It is cost-saving in the high wage environment, so only adopted in the high wage environment.

The iso-cost line of low wage environments cannot shift as it would have to adopt new tech, which does not happen as wages are too low to provide that incentive.

Question 17

What is the most key input in modern economic growth?

Answer 17

Capital accumulation

Question 18

What is the equation of the Solow model?

Answer 18

Y = AK_t^αN_t^1-α

0 < α < 1, α roughly equal to 0.3

Question 19

What is the per worker as a function of capital per worker?

Answer 19

Y_t/N_t = A_tk_t^α

Question 20

Draw the relationship between output per worker and capital per worker.

Answer 20

Question 21

What is the equation for capital, K?

Answer 21

K_t = (1 - d)K_t-1 + sY_t

d = rate of depreciation, sY_t = saved output (i.e. investment)

Question 22

What is the equation for capital per worker, k?

Answer 22

K_t/N_t = k_t = (1 - d - n)k_t-1 + sy

d = rate of depreciation of capital, n = rate of depreciation of labour, sy = investment per capita

Question 23

Draw the Solow model and explain it.

Answer 23

Where capital is less than k_SS, capital accumulation (i.e. sy=I) is greater than capital depreciation (i.e. (n+d)k).
If capital is greater than k_SS, capital accumulation (i.e. sy=I) is less than capital depreciation (i.e. (n+d)k).

Steady state level of capital is at k_SS.

Consumption per worker is the difference between sy and f(k).

The lower the amount of capital in an economy, the faster the economy should grow.

Question 24

What are the problems with the Solow model?

Answer 24

Assumes all countries have access to the same amount of technology, A.

This is obviously not true.

Question 25

Why do countries not all have access to the same amount of technology?

Answer 25

Very hard to invent and quite hard to import (Japan did it, but they're one of the only ones)

Question 26

Why did some countries not join the "convergence club"?

Answer 26

Countries in Africa adopt "Import-Substitution-Industrialisation". Don't import, but make everything yourself - very difficult as making your own technology is really hard. Asian Tigers adopt Export led industrialisation. Protect infant industries in sectors where you expect a comparative advantage. Labour intensive, import machinery and machine tools. Successful export firm gain government support, others do not.

Question 27

How did China join the convergence club?

Answer 27

Personal responsibility reforms, reducing amount of collectivisation post-Mao. Agricultural output increased by around 50% in certain regions. Export zones created with very free markets increasing foreign investment.

Question 28

What are the best paths to join the convergence club?

Answer 28

Increase market mechanisms (rent seeking, export led growth) Decrease political rent seeking

Question 29

Why is it difficult to join the convergence club?

Answer 29

* The main comparative advantage that poor countries have is in agriculture, but it is not a free trade globally. * East Asian wages still being low means that they will need to increase before Africa becomes a competitor (cost of new roads, new factories, corruption etc. are high so firms won't do it until it becomes economically viable to do so) * Geography, history is a major constraint (Central Africa so far from the sea, cost of debt from corrupt politicians in Africa)