Chapter 4 (Combining Solow and Romer)

Question 1

What is the key to long run economic growth?

Answer 1

Non-rivalry of ideas

Question 2

Transition dynamics

Answer 2

if an economy starts out below its balanced growth path, it will grow rapidly in order to catch up to this path; if an economy begins above its balanced growth path, it will grow slowly for a period of time.

In the short run, counties grow at different rates. In the long run, countries grow at the same rate.

Assume that there is a balanced growth path in the long run, as all endogenous variables are growing at a constant rate

Question 3

What are the 5 unknowns in the combined model?

Answer 3

• Output, Y_t
• Capital, K_t
• Knowledge, A_t
• Workers in the output sector, L_yt
• Workers in the research sector, L_at

Question 4

What are the 5 equations?

Answer 4

Question 5

What is the growth rate of the production function?

Answer 5

• The growth rate of capital is equal to the growth rate of ouput because Y_t/K_t must be constant so they grow at the same rate

Question 6

Why is the growth rate of capital determine the growth rate of output?

Answer 6

Fraction of output over capital is constant along a balanced growth path, therefore the growth rate of capital follows the growth rate of output

Question 7

Why is output higher?

Answer 7

Ideas have direct and indirect effect

Increasing productivity raises output because productivity has increased

Higher productivity results in a higher capital stock

Question 8

Charter cities

Answer 8

Drawing inspiration from the historical experience of Hong Kong, Professor Romer suggests that new cities be established. In these charter cities, advanced economies would agree to set the rules by which the new city is administered. People from throughout the world would then be free to live and work in the new city. Such cities could even be established in developing countries with a charter that grants administrative rights to one or more advanced economies.

E.g. Hong Kong

Question 9

Monopolisitc competiton, according to Romer

Answer 9

That is, if increasing returns are the key to growth, why wouldn’t the economy come to be dominated by a single, very large firm? After all, such a firm would enjoy the best advantage of increasing returns. Romer’s answer was to incorporate the modern theory of monopolistic competition into his idea model. In this theory, the economy contains many monopolists, each producing a slightly different good. They compete with each other to sell us different varieties of music, books, computers, and airplanes. Their size, as Adam Smith said, is limited by the extent of the market as well as by competition with each other.

Question 10

Why is growth even higher in the combined model?

Answer 10

Ideas have direct and indirect effects

Increasing productivity raises output because productivity has increased

Higher productivity results in a higher capital stock

Question 11

Capital output ratio

Answer 11

saving rate/ growth rate of output + depreciation

Shows investment rate along a balanced growth path

g_k^*=g_y^*

Question 12

What does * mean?

Answer 12

Variables are evaluated along a growth path

Question 13

What is the proof for capital output ratio

Answer 13

Question 14

Intergrating the capital output ratio into the production function

Answer 14

Question 15

Proof for the combined Solow-Romer production function

Answer 15

Question 16

Raising the investment rate in the production function (change in parametr)

Answer 16

Raises output per person in parameter

Increase in growth path until the new growth path is reached

Since the economy is now below its new balanced growth path, the principle of transition dynamics says that the economy will grow rapidly. Notice that y_t is plotted on a ratio scale, so the slope of the path is the growth rate.

output per person is permanently higher as a result of the increase in the investment rate, but the growth rate is unchanged. This is sometimes called a long-run “level effect.”

Question 17

What factors create transition dynamics?

Answer 17

changing any parameter of the model—s̅, d̅, z̅, L̅, ℓ̅, K̅₀, or A̅₀—will create transition dynamics