Econ exam 2

Question 1

How do you track economic growth?

Answer 1

Real GDP per capita
o Real GDP/ population size
o This provides a measure of the quantity of goods and services available to the typical resident of a country at a particular time.

Growth rates
o Rule of 70
 Tells the time it takes for something to double
 70/annual growth rate of variable

Question 2

What is the source of long-run growth?

Answer 2

Sustained economic growth occurs only when the amount of output produced by the average worker increases steadily

Question 3

Why has there been growth in productivity?

Answer 3

Physical capital
* Machinery, office space
Human capital
* Education is better
Technological progress

Question 4

What is physical capital and what does it do for workers?

Answer 4

Human-made resources such as building and machines

Ultimately making workers more productive

Question 5

What is human capital?

Answer 5

Improvement in labour created by the education and knowledge embodied in the workforce

Question 6

What is technological progress?

Answer 6

An advance in the technical means of the production of goods and services.

Question 7

When is the aggregate real output for an economy higher?

Answer 7

Aggregate real output for an economy is higher when:

More physical capital is used More labour is used
More human capital is used and or technology improves

Question 8

What is the aggregate production function?

Answer 8

Y = A x F(K,L,H)

Y = aggregate real output (GDP)

K = amount of physical capital used

L = amount of labour used

H = amount of human capital used

F (…) = aggregate production function

A = total factor productivity

Question 9

If total factor productivity rises, does aggregate real output rise?

Answer 9

yes

Question 10

An increase in K in the function does what?

Answer 10

An increase in K causes the amount of aggregate real output to rise by a marginal amount called:

Positive marginal productivity of physical capital (positive MPk)

Question 11

How do you measure if productivity is higher?

Answer 11

we use the per worker production function:

o This shows how productivity depends on the quantity’s pf physical capital per worker and human capital per worker as well as the state of technology:

Question 12

What is the Per worker production function?

Answer 12

(Y/L) = A x F((K/L), (H/L))

• Y/L = real output per worker (GDP)
• K/L = real physical capital per worker
• H/L = human capital per worker
• A = total factor productivity

Question 13

What does the per worker production function exhibit?

Answer 13

Diminishing returns to physical capital
* Called: diminishing marginal productivity of (physical) capital (dim MPk)

• That is, when the human capital and state of technology are fixed, each successive increase in the amount of physical capital per worker leads to a smaller increase in output per worker, or productivity

Question 14

Growth accounting does what?

Answer 14

Estimates the contributions of each major factor in the aggregate production function to economic growth

Question 15

How do natural resources impact economic growth?

Answer 15

Countries that are abundant in valuable natural resources have a higher real GDP per capita

Question 16

How come growth rates differ?

Answer 16

Countries with rapid growth tend to do the following:

o Rapidly add to their physical capital through high savings an investment spending
o Increase their human capital by improving their educational institutions
o Make fast technological progress through research and development

Government policies are also important

Question 17

Savings and investment spending comes from where?

Answer 17

Must be paid for either out of domestic (national) or out of foreign savings

Domestic savings comes from
o Households or governments

Foreign savings come from
o Borrowing from abroad

Question 18

Research and development

Answer 18

Definition:
o Spending to create and implement new technologies

• Technology is a key force in economic growth

Question 19

What is the role of the government in promoting economic growth?

Answer 19

• Government policies can increase the economy’s growth rate through the following six channels:

Government subsidies to infrastructure
 Building roads, power lines, information networks, and other large-scale physical capital projects providing a foundation for economic activity

o Government subsidies to education

o Government subsidies to R&D

o Maintaining a well-functioning financial system

o Protection of property rights

o Political stability and good governance

Question 20

What is the convergence hypothesis?

Answer 20

International differences in real GDP per capita tend to narrow over time

Question 21

Is it possible for growth to continue in the face of limited supply of natural resources?

Answer 21

Yes, through sustainable long-run economic growth:
 Is long-run growth that can continue in the face of the limited supply of natural resources and with less negative impact on the environment

Question 22

How does economic growth impact the environment?

Answer 22

Economic growth tends to increase the adverse impact of human activity on the environment, including an increase in pollution, the loss of wildlife habitats, extinction of species, and reduced biodiversity.

Question 23

What is the savings-investment spending identity?

Answer 23

Savings and investment spending are ALWAYS equal

Savings-investment spending identity:

• Savings and investment spending are always equal for the economy as a whole

Question 24

Savings-investment identity in a closed economy excludes what?

Answer 24

In a closed economy there are NO exports or imports
o Therefore:
 GDP = C + I + G

Question 25

What are national savings?

Answer 25

Is the total amount of domestic savings generated within an economy, it equals current income less spending on current needs

o National savings = GDP – C – G
o The sum of private savings + public savings

Question 26

What is private savings?

Answer 26

(GDP – T + TR) – C
- Is the amount households and businesses save from private-sector income.

• Gives government taxes and the government gives private sectors transfers (pensions, EI, Child benefits etc)
• Private savings = I + Government budget deficit
  o In a closed economy Private savings finance two things
   Investment by firms
   Budget deficits by the government

Question 27

What are public savings?

Answer 27

T – G
- Is the amount that governments save from public sector income
o Also known as the governments budget balance
o If T is bigger than G than it is a budget surplus
o If G is bigger than T than it is a budget deficit
- Net taxes (T) = total taxes – transfer payments – interest

Question 28

What are transfer payments?

Answer 28

Payments the government makes to the public for which it receives no current goods or services (e.g. Social security benefits, welfare payments)

Question 29

What is Net Capital Inflow?

Answer 29

In an open economy, foreigners can invest in the economy and so we must also consider the net capital inflow
- Net capital inflow
o Net capital flow of funds into a country minus the total flow of funds out of a country
- This can also finance investment therefore,
o Private savings + NCI = I + government deficit

Question 30

How do you know when a country is financing from the rest of the world?

Answer 30

If an economy has investment and government deficit higher than what can be financed by domestic savings, the difference must be financed from savings from the rest of the world.
- Example: USA has a trade deficit with China. Hence USA must be borrowing from China.

Question 31

What is the Domestic Market for loanable funds?

Answer 31

The loanable funds market:
o A hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders

Question 32

Why does the loanable funds market have a negative slope and what factors cause it to shift?

Answer 32

o The higher the interest rate the higher the opportunity cost which reduces the amount of investments from companies, therefore the slope is negative.

o When a firm engages in investment spending (buying new equipment) they’re laying out money right now and expect that this outlay will lead to higher profits in the future. We consider present value to determine how much higher.

Factors that cause the domestic demand curve to shift:
o Changes in perceived business opportunities
o Changes in government policies that affect investment

Question 33

What is present value?

Answer 33

The amount of money needed today in order to receive X at a future date given the interest

Question 34

Why is the domestic supply of loanable funds curve positive and what factors cause it to shift?

Answer 34

o Loanable funds are provided by savers, and savers incur an opportunity cost when they lend to a business. Whether a given saver becomes a lender by making funds available to borrowers depends on the interest rate received in return.

Factors that cause the supply curve to shift:
o Changes in private savings behavior
o Changes in government budget balance

Question 35

Savings and real interest rate

Answer 35

The higher the interest rate the greater the reward for saving, so people will be more inclined to save

The interest rate may also affect your income:
o If you’re a net borrower a higher interest rate will decrease your wealth (example: higher mortgage payments). More savings.
o If you’re a net lender a higher interest rate will increase your wealth (greater return on your assets). Since present income hasn’t changed this leads to less savings.

Question 36

The equilibrium interest rate

Answer 36

The interest rate at which the quantity of loanable funds supplied equals the quantity of loanable funds demanded

Question 37

What is crowding out?

Answer 37

• Occurs when a government budget deficit drives up the interest rate and leads to reduced investment spending
• Reduced investment spending implies lower capital formation, and thus lower economic growth.
• This adverse effect of budget deficits on economic growth is a key reason that economists advise governments to minimize their deficits
• However, an increase in government spending (funded by larger deficits) may increase the level of GDP, thus it might lead to only a small decrease in national saving.

Question 38

Why save?

Answer 38

Life-cycle saving: Saving to meet long-term objectives such as retirement, college attendance, or the purchase of a home

Precautionary saving: Saving for protection against unexpected setbacks such as the loss of a job or medical emergency

Bequest saving: Saving for the purpose of leaving an inheritance

Basically, saving is sacrificing present consumption to obtain future consumption.

Question 39

Why do firms invest?

Answer 39

Investment – the creation of new capital goods and housing, i.e. capital formation – is critical to increasing average labor productivity and improving standards of living.

• Firms acquire new capital goods for the same reason they hire new workers: they expect that doing so will be profitable!
• The interest rate is the price of borrowing funds.
• Firms borrow more when the interest rate falls because more projects will earn enough to pay for themselves.

Question 40

What are the effects of a new technology on national saving and investment?

Answer 40

A technological breakthrough raises the marginal product of new capital goods, increasing investment and the real interest rate.

Question 41

What are the effects of an increase in the government budget deficit on national saving and
investment ?

Answer 41

Increases in the budget deficit reduces the supply of national saving, raising the real interest rate and lowering investment

Question 42

What is Marginal Product of labor?

Answer 42

the extra output generated by adding one more worker (or hour).

Question 43

How do you calculate the average product of labor?

Answer 43

Total output divided by the number of workers (or total hours)

Question 44

What was Thomas Malthus view on growth?

Answer 44

Malthus said that if you get a surge in population growth, the result will be famine, war, and disease, which will lower the population again. This is because he thought that while population grows exponentially food production could only grow linearly. This is because he believed in diminishing marginal product of labor.

Question 45

What are the 6 factors that account for the differences in average labor productivity?

Answer 45

Human Capital, Physical Capital, technology, natural resources and land, management and entrepreneurship, political and legal environment

Question 46

Y/POP = what?

Answer 46

Y/POP = Y/N x N/POP

Question 47

What caused East Asia’s Miracle?

Answer 47

• Low labor costs attracted foreign corporations to set up International Supply chains
• Very high savings rates allow businesses to borrow and add more physical capital per worker.
• Big fraction of the savings is invested in education improving human capital.
• Substantial technological progress.

Question 48

Africa’s Troubles and Promise

Answer 48

What’s holding much of Africa back?
– Government corruption
– Civil wars & political instability
– Unfavorable geography