7 Growth and Ideas

Question 1

What do we class as objects?

Answer 1

Most goods we are familiar with e.g. phones, land, oil, paper; as well as capital and labour from the Solow model.

Question 2

What do we class as ideas?

Answer 2

Things like instructions, recipes, designs etc.

Question 3

Chain of thinking from ideas to problems with pure competition

Answer 3

ideas → non-rivalry → increasing returns → problems with pure competition

Question 4

How does economic growth occur through ideas?

Answer 4

We discover better and better ways to use the finite resources available to us.

Sustained economic growth occurs because we discover new ideas.

Question 5

How do ideas link to concepts of rivalry and excludability?

Answer 5

Ideas are non-rival; using an idea does not limit someone else’s ability to use that idea.

Ideas are not non-excludable; countries have developed intellectual property laws to grant rights to the use of ideas, excluding anyone that does not have such rights.

Question 6

What returns to scale do ideas have?

Answer 6

Increasing returns to scale.

Question 7

Why do ideas have increasing returns?

Answer 7

Consider pharmaceutical company that spends $2.5 billion to develop a new drug, plus $10 in manufacturing costs. Producing first dose costs $2.5 billion + $10 dollars. If we increase production and spend another $2.5 billion, we produce 250 million doses.

Therefore by doubling inputs (investing another $2.5 billion), we have more than doubled output, hence increasing returns.

Question 8

Why is there a problem with pure competition and economics of ideas?

Answer 8

Any time a new idea is invented, there is a fixed cost to produce it. After this, if the firm was to have price equal to marginal cost, the original fixed cost would sink. Hence, there would be no incentive to develop new ideas.

Question 9

How is the problem of pure competition and economics of ideas tackled?

Answer 9

Patents and copyright where firms that innovate are rewarded with a 20 year monopoly if they make the knowledge public, incentivising innovation.

Another way is trade secrets (also protected by law).

Alternatively, governments can either conduct research themselves, or subsidise the key inputs into research: the education of scientists and engineers.

Question 10

Example: Pharmaceutical company that invested $5 billion into R&D for a new cancer drug. The marginal cost per treatment per year is $1,000, but in order to cover the original cost, they charge a price of $10,000.

How does this cause a surplus? Wider implications of this?

Answer 10

There exist people that are willing and able to pay the $1,000 but not the $10,000, so they are priced out of the market. This creates a loss in surplus.

A single price cannot create incentives for innovation and allocate scarce resources efficient.

Question 11

General output formula for economics of ideas

Answer 11

Question 12

General ideas production formula

Answer 12

Question 13

Constraints for output and idea production

Answer 13

Question 14

Romer model: 4 equations, 4 unkowns

Answer 14

Question 15

5 steps when solving the Romer model

Answer 15

Question 16

Why is there growth in the Romer model?

Answer 16

The non-rivalry of ideas means that per capita GDP depends on the total stock of ideas.

The Solow model = the accumulation of capital runs into diminishing returns

The Romer model = the exponent of A is equal to 1, it is not diminishing. Old ideas continue to help us produce new ideas in a virtuous cycle that sustains economic growth.

Question 17

What is meant by the balanced growth path?

Answer 17

The Romer model does not exhibit transition dynamics the same way the Solow model does. In the latter, the growth rate declines as it reaches the steady-state, in the Romer model the growth rate is constant (in its steady state).

We call this constant growth the balanced growth path.

Question 18

Romer model: effect of changing the population + diagram for increased population.

Answer 18

Question 19

Romer model: effect of changing the research share + diagram for increased share

Answer 19

Question 20

What is the assumption for most Romer equations and modelling? Is it always the case?

Answer 20

That the exponent to A is 1.

Not always the case, but it is the case that it is always positive.

Question 21

Answer 21

Question 22

Implication of A always having a positive exponent

Answer 22

The fact that growth is sustained (due to non-rivalry) is not dependent on the “strength” of increasing returns.

Predictions of the Romer model are sensitive to the degree of increasing returns.

Question 23

Growth effect and the level effect

Answer 23

Growth effect: changes in parameters lead to permanent increases in the rate of growth of per capita GDP.

• Eliminated when the degree of increasing returns is not strong.
• This way increases in researcher share or population size increases growth rate in the short run, but in the long run it returns to the original rate - like transition dynamics.

Instead more researchers producing more ideas raises the long-run level of per capita GDP - the level effect.

Question 24

What is the equation for the growth rate of each of these factors?

Answer 24

Question 25

How do we get from the output growth rate equation to output per capita growth rate?

+ implication

Answer 25

We can measure everything but the last value, which is TFP. Therefore we can just deduce TFP.

Question 26

What 5 unknowns and 5 equations do we use when combining the Solow and Romer models?

Answer 26

Question 27

Long-run growth in the combined model

[5 steps]

Answer 27

Question 28

Output per capita in the combined model

[4 steps]

Answer 28

Question 29

How do transitition dynamics work in the combined model compared to Solow’s?

Answer 29

Original Solow model → diminishing returns, so increases in capital stock increase the level of output less and less each time.

Combined → capital still exhibits diminishing returns, so transition dynamics still apply. Here, we are concerned with the balanced growth path.

Question 30

How can we show a sudden, permanent increase in the saving rate?

Answer 30

We see the growth rate (slope of the line) increases than gradually declines back to balanced growth rate.

We see a permanent increase in the level of output per capita (the long-run level effect).