Chapters 7 and 8

Question 1

What are classical economic models?

Answer 1

• Economic model that assumes wages and prices adjust freely to changes in demand / supply.

Question 2

Production function.

Answer 2

• Relationship between the level of output of a good and the factors of productive that are inputs to production.
• Y = f(K, L).

Question 3

Stock of capital.

Answer 3

• K in the production function.

* All machines, equipments, and buildings to an entire economy.

Question 4

Real wages.

Answer 4

• The wage rate paid to employees adjusted for changes in the price level.

Question 5

What is the ideal value combination for labor supply and real wages?

Answer 5

• Where the labor supply function intercepts the labor demand function.

Question 6

How is the relationship between real wages and labor supply relevant to booms and busts?

Answer 6

• The demand function shifts to the right for booms.

* The supply function shifts to the right for busts.

Question 7

Real business cycle theory.

Answer 7

• Economic theory which emphasizes how technological advances can cause fluctuations in economic activity.

Question 8

Crowding out vs. crowding in.

Answer 8

• Crowding out: reduction in investment due to increased gov’t spending.
• Crowding in: increases in investment due to decreases in gov’t spending.

Question 9

Closed economy vs. open economy.

Answer 9

• Closed economy: one without international trade, where GDP is Y = C + I + G.
• Open economy: one with trade where GDP is Y = C + I + G + NX.

Question 10

Capital deepening.

Answer 10

• Increases in the stock of capital per worker.

Question 11

Technological progress.

Answer 11

• More efficient ways of organizing economic affairs that allow economy to increase output without increasing input.

Question 12

Human capital.

Answer 12

• Knowledge and skill acquired by workers through education and experience.

Question 13

Real GDP per capita.

Answer 13

• The usual measurement for standard of living.

* GDP per person adjusted for changes in prices.

Question 14

What is the formula for GDP growth in n years?

Answer 14

• GDP [n years later] = (1+g)^n (100), where g is the growth rate.

Question 15

Rule of 70.

Answer 15

• Rule of thumb that says output will double in 70/x years where x is the % rate of growth. Years to double = 70/g.

Question 16

Convergence.

Answer 16

• Process by which poorer countries close the gap with richer countries in terms of real GDP per capita.

Question 17

What does capital deepening do to the production function?

Answer 17

• The graph is stretched upwards.

Question 18

Savings.

Answer 18

• Income that is not consumed.

* C + S = Y for personal; C + I = Y for businesses; therefore, S = I.

Question 19

Net investment.

Answer 19

• Gov’t spending - personal savings.

Question 20

Growth accounting.

Answer 20

• Measure of economic growth that depends on capital, labor, and technological progress. Y = F(K, L, A).

Question 21

Labor productivity.

Answer 21

• How much output the avg. worker can produce given the amount of capital in the economy and the technological progress.

Question 22

Creative destruction.

Answer 22

• View that firms will try to come up with new products and more efficient ways to produce stuff in order to have a monopoly.

Question 23

What did Adam Smith say regarding the scale of a market and its impact?

Answer 23

• That the larger the market, the larger potential profits margins may be. Thus, larger markets spur innovation.

Question 24

Induced innovation.

Answer 24

• Innovation that cuts cost.

Question 25

What are the two ways in which education spurs economic growth?

Answer 25

• Increased knowledge and skill that complement physical capital.
• Education leads to innovation and development of new stuff.

Question 26

New Growth Theory.

Answer 26

• Modern theories of growth that try to explain the origins of technological progress.

Question 27

What are the shortcomings of CPI?

Answer 27

• Substitution bias: people tend to buy cheaper stuff.
• Outlet bias: buying at outlet stores vs. typical department stores.
• New good bias: high initial prices for new goods.
• Quality bias: more quality per $ isn’t accounted for.

Question 28

What is the connection between absence of clear property rights and investment?

Answer 28

• Unclear property rights hinder economic growth as they are disincentives for investment.

Question 29

Explain the relationship between savings and depreciation.

Answer 29

• The output curve and its subsequent lower curve representing % of output dedicated to savings will intersect the depreciation function which runs linearly at a given point. This point is the idea amount for a company to save.

Question 30

What will a higher savings rate lead to in the long run?

Answer 30

• A larger stock of capital.

Question 31

What does technological progress do to the savings function?

Answer 31

• Stretches it upwards, thereby promoting capital deepening.

Question 32

What are the four facets of the Solow Model?

Answer 32

• Capital deepening occurs as long as savings > depreciation.
• Capital deepening will halt as depreciation catches up to savings.
• Higher savings promote capital deepening.
• Technological progress will promote both capital deepening and output.