Demand And Production In LR model (+econ growth)

Question 1

1. What simplifications do we make for the LR production model?
2. What assumptions do we make?

Answer 1

1. Single, closed economy
   Flexible prices, markets clear
   One good consumed and produced
2. Constant returns to scale (do you remember the lambda?)
   Diminishing marginal returns

Question 2

What happens if a firm has constant returns to scale between output, marginal produces and factor prices?

Answer 2

Y = MPLxL + MPKxK

By Euler’s THM

Question 3

What explains differences in output per capita?

Answer 3

Remember equation for output per capita. It depends on A and k*, but for the latter the issue is that due to diminishing marginal returns to capital one would expect difference to be slightly smoothed out. So the issue is differences in TFP (ie A)

Question 4

DEF: real interest rate

Answer 4

1. Cost of borrowing

2. Opportunity cost of using one’s own funds to finance investment spending

Question 5

Where does D and S of loanable funds market come from? When is equilibrium reached?

Answer 5

D: comes from investment (fct of r)depends negatively on r

S: comes from government (T-G) and households (Y-T) - C.
Total national saving is S= Y - C - G
Which is same as national income identity rewritten as I = Y -C - G

Do equilibrium reached when S= I(r)

Question 6

What results in…

1. Shifts in the savings curve?
2. Shifts in investment curve?

Answer 6

1. Change in G, T (public saving) or preferences or tax laws that affect saving (private saving)
2. Technological innovations (firms needing to buy new investment goods), tax laws that affect investment.

We assume the supply of loanable funds is fixed, so a change in 2. will only raise r

Question 7

What is the ‘rule of 70’? What’s so special about it?

Answer 7

If x (perhaps initial GDP/capita) is growing at a rate g, then the time (number of years) it takes for it to double is approximates equal to 70/g.

Soooo…
It doesn’t matter what the initial level is for it to double over 70/g years
Small differences in the growth rate can result in large differences over time

Question 8

Pros economic growth?

Answer 8

1. Increased variety of goods and services
2. Improved incomes
3. Health improvements
   - > overall standards of living rise

Question 9

Cons economic growth?

Answer 9

1. Environment
2. Job loss
3. Inequality