chapter 2.2

Question 1

What is Economic growth?

Answer 1

• sustained expansion of production possibilities measured as the increase in real GDP
• economic growth → refers to the economic performance over long period of time. It can lead to substantial and sustained improvements the living standards of the population

Question 2

What is Business cycle expansion?

Answer 2

occurs when the economy is recovering from a recession

Question 3

Economic growth brings wealth, which increases societal well-being. What does wealthier nations have?

Answer 3

• higher infant survival rates, life expectancy, and nutrition
• more educational opportunities, leisure, and entertainment
• fewer conflicts such as civil wars and riots
• more material goods

Question 4

What are some key facts about economic growth and the wealth of nations?

Answer 4

• GDP per capital varies enormously among nations
• everyone used to be poor
• There are growth miracles and growth disasters

Question 5

What are the differences between 2 types of economic growth?

Answer 5

• catching-up growth → occurs through capital accumulation and may imply strong growth rates, but only during transitory periods
• cutting-edge growth → can be sustained in the very long run
  → fundamental precondition: system of incentives creasted by institutions (property rights, honest governments, dependable legal system)

Question 6

In the solow growth model, what does the total output of an economy (y) depends on?

Answer 6

• physical capital (k)
• human capital, or education * labour (eL)
• ideas (A)
• assume that A, e and L are constant

Question 7

What is the marginal productivity of capital (MPK)?

Answer 7

• more capital (K) should produfce more output (Y) but at a dimishing rate
• MPK diminishes because the first unit of capital is applied where it is mos productive, the second unit where it is slightly less productive, and so on

Question 8

In the solow growth model, explain consumption and investment

Answer 8

• output can be either consumed or saved/invested in capital goods
• assume the investment rate (ɣ), the fraction of output invested, is constant

Question 9

In the solow growth model, explain capital depreciation

Answer 9

• capital also depreciates (wears out). Assume the depreciation rate (𝛿), the fraction of capital that wears out, is also constant
• the greater the capital stock, the greater the depreciation. This places another constraint on economic growth

Question 10

Explain the steady state level of capital

Answer 10

the amount of physical capital (k) is a stock variable that evoloves according to the level of investment and depreciation

K_t+1 = K_t + I_t - Depreciation_t

𝑲_𝒕+𝟏 − 𝑲_𝒕 = 𝜸𝑭(𝑲_𝒕) − 𝜹𝑲_t

Question 11

Explain the steady state level of output

Answer 11

• when capital is in the steady state, output is also n the steady state

Question 12

What is happening to capital per capita (k=K/L) and GDP per capita (y=Y/L)?

Answer 12

• assuming L is constant, k and y are proportional to K an Y
• suppose now that L is growing at a constant rate n: L_t+1=(1+n).L_t
  With some transformamtions, we can derive the following formula for the evolution of capital per capita:
  𝒌_𝒕+𝟏 − 𝒌_𝒕 ≈ 𝜸𝒇(𝒌_𝒕) − 𝜹𝒌_𝒕 − 𝒏𝒌_𝒕

Question 13

Take 2 coutries with same F(L,K), 𝛾 and δ. If capital is different in the 2 coutries, which country is growing faster?

Answer 13

a country with lower initial capital grows faster → catching-up growth leads to condutional convergence across similar countries

Question 14

What happens in the investment rate increases? Or the depreciation rate decreases?

Answer 14

steady state levels increase. economy grows in the transition to new steady state, but not in the long run → catching-up growth

Question 15

What happens if technology increases?

Answer 15

steady state levels increase. economy grows in the transition to new steady state. but now the movement can be repeated, and we can have growth in the very long run → cutting-edge growth

Question 16

What is conditional convergence?

Answer 16

• coutries with the same characteristics (production function, investment rate, depreciation rate) should converge to the same real GDP per capita

Question 17

What happens in the solow growth model if investment rate increases?

Answer 17

• raises steady state output
  predicts:
• countries will be wealthie

Question 18

Why can’t catching-up growth be sustained forever?

Answer 18

• long-run economic growth cannot be due to capital accumulation alone
• diminishing returns means that eventually capital and output will cease growing. The logic of diminishing retuns applies to human capital as well

Question 19

Why can cutting-edge growth be sustained by technological progress?

Answer 19

• technological progress increase output even while holding K constant
• increase in total factor productivity
• better ideas can keep the economy growing even in the long run

Question 20

What are some limitations of the solow growth model?

Answer 20

• growth is exogenous: the model does not provide an explanation for why technological changes occur
  → exogenous: a variable that is determined externally
  → endogenous: a variable that is determined within the model
• if economies have acess to the same technologies and capital is free to roam the globe (seeking the highest available real interest rate), then GDP per capital should converge across all countries (absolute convergence)
  → this doesn’t happen! there are many coutries that started poor and still observed modes growth rates (with none of very little convergence to the top)

Question 21

what drives the accumulation of factors of production?

Answer 21

• system of incentives that make people
  → incentive in physical capital
  → invest in education and training (to build human capital)
  → invest in research and development (to foster innovation and new technology)

Question 22

what drives proper incentives?

Answer 22

institutions

Question 23

what dirves the production of new ideas?

Answer 23

• ideas are primarily researched, developed, and implemented by profitseeking frims (just like for other factors of production)
• but ideas are special, because they can be freely shared and used by others (non-rival goods). Positive spillovers imply that ideas are typically underprovided (social benefit is larger than private benefit)
• government has a role in improving the production of ideas
  → patents
  → subsidies to R&D
• opening up to trade can also play a role. the larger the market, the greater the incentive to research and develop new ideas

Question 24

what are the 2 important facts that create new growth theories (making growth an endogenous phenomenon)?

Answer 24

• knowledge is (eventually) a public good - non-rivbal and only partially excludable
• knowledge is not subject to diminishing returns - increasing the stock of knowledge makes capital and labour more productive

→ the people have incentive to innovate (increase profits) and this will increase everyone’s productivity
→ Growth is internally (endogenously) determined and can go on forever!