EC1B3 Flashcards
What is GDP
Total market value of all final goods and services produced within a specific territory in a given period of time
What are 3 ways of measuring GDP (all identical measures of GDP)
- Production measure - number of goods produced
- Expenditure measure - total purchases
- Income Measure - all income earned
How do you calculate the expenditure approach to GDP
Y = C + I + G + (NX)
Y = GDP
C = Consumption
I = Investment
G = Government Purchases
NX = X - M = Exports - Imports
Calculate the income approach to GDP
Measures the sum of all income earned in the economy
What are the normal shares of GDP to labour or capital
Labour - 2/3
Capital - 1/3
How do you measure the Production Approach to GDP.
- Value Added = Final revenue - value of intermediate products.
- Only new production of g/s towards GDP.
What is the difference between how real GDP and nominal GDP is calculated
Real GDP: price base year * quantity current yr
Nominal GDP: price current yr * quantity current yr
What is the implicit price deflator
(Nominal GDP/Real GDP) * 100
How do you calculate CPI
((base yr q * current yr p) / (base yr q * base yr p)) * 100
What is the difference between the CPI and Implicit GDP price deflator
CPI includes
1) only goods purchased by consumers
2) quantities are fixed at base year.
whereas Implicit GDP price deflator fixes prices at base year.
What are the problems in measuring real GDP and the price level
What is the difference between the Laspreyes and Paasche Indexes
How do you remember it
Laspreyes - Using initial for base in index
Paasche - using final for bases in index
What is the equation for nominal GDP.
How do the percentages calculate
Nominal GDP = price level * real GDP
% change in nominal GDP = % change in price + % change in real GDP
What is the rule of 70
If y grows at a rate of g percent per year, than the number of years it takes y to double is approx. equal to
70/g = number of years to double
What is the set up of the standard production function model
What is the Cobb Douglas function.
Exhibits constant returns
Derive the GDP per capita form of the production form
e.g. from Y=AK^1/3L^2/3
How do companies allocate resources under profit maximisation
What is the interpretation of the solution to how firms allocate resources
Equilibrium wage prop. to output per worker
Equilibrium rental rate prop. to output per capital
Factor shares of payments are equal to the exponents on the inputs in the Cobb-Douglas.
What is the constant growth rate rule
How does the ratio scale change how you interpret the graph
How can you use the constant growth rate to compute the growth rate
What are the growth rate laws
How do you calculate if the production function has increasing or decreasing returns to scale
- Sum of the exponents.
- if >1 then IRS. If < 1 then DRS.
- Each factor on its own can also have increaseing or decreasing returns to scale
What is A in the Production Function
The TFP - Total Factor Productivity; efficiency of utilising factor inputs.
Known as the ‘residual’ as calculated as part that makes up the GDP.
3 times as important as capital per person.
Q2.
Do these functions have increasing or decreasing returns to scale
How does the Solow Growth Model augment the Production Model.
- Capital stock is endogenised –> add equation for accumulation of capital
- Resource constraint for Investment and Consumption
- Labour exogenous (Lt=L bar)
- Saving = Investment
What are the equations related to capital in the Solow Growth Model
What are the saving and investment equations in the Solow Growth model
How do you solve the Solow Growth Model
Combine sY=I and Kt+1= I - dKt
Graph sY and dK on graph w axis I,d and Kt
What are the transistion dynamics of the Solow Growth Model
Economy will always transistion to where △Kt = 0 (steady state)
What happens to Output during the transistion dynamics
Moves along w transition dynamics as capital is part of Output
Solve for the steady state mathematically with K * and Y *
Solve the steady state mathematically but for output per person
In Solow Growth Model what is the real interest rate and the return on saving
- Real interest rate - amount a person can earn/pay by saving/borrowing one unit of output for a year
- Return on saving is equal to the rental price of capital = real interest rate = mpk
At steady state, how is the capital to output ratio and investment rate to depreciation ratio related
What are the implications
Since depreciation rate is fairly constant
Savings rate drives the Capital per Output ratio
Why does the Solow Growth Model reach a steady state
- Investment has diminishing returns
- Rate at which production and investment rise is smaller as capital stock is larger
- Depreciation is not diminishing as capital increases
Eventually net investment is 0.
What is Economic Growth like in the Solow model
Therefore, Capital Accumulation is not engine of long-run growth
Savings and investment are beneficial in short run, but in LR not due to diminishing returns.
How does population growth interact with the Solow Growth Model
What is the result of an increase in the investment rate
- Investment curve rotates upwards.
- Depreciation curve unchanged
- Capital stock + output increase to new steady state
What is the result of an increase in the depreciation rate
- Depreciation curve rotates upwards
- Capital stock + output declines to new steady state
Declines rapidly at first and the gradually sttles
How does being further or closer affect the changes in output
- Output changes more rapidly if we are further from the steady state.
e.g. Poor countries grew quickest
- As steady state approaches, growth shrinks to 0.
What are the implications of the Solow Growth Model on dunerstandting rich and poor countries
Most Countries at steady state
Countries are poor due to parameters that tield a lower steady state (investment, A, determinants of steady state)
What are the weaknesses of the Solow Growth Model
What does the Romer model derives into 2
- Objects
* Capital and labour from the Solow model
* Finite - Ideas
* Used to make objects
* Virtually infinite
Sustained economic growth occures because of new ideas
Where are the IRS and CRS when creating a new vaccine
What is the Romer Model production function
When are there CRS and IRS
What is Pareto Optimal Allocation
When does it occur
Cannot make someone better off without making someone else worse off
Perfect competition P=MC
Vaccine company never does research for ideas with P=MC
How do you encourage innovation
- Patents
- Gov. Funding
- Prizes
- Altruism
What are the idea equations in the Romer Model
What are the population equations in the Romer model
What is the growth rate of technology in the Romer Model and how do you show it is constant
g = z* l* L
Why is there growth in the Romer Model
- No diminshing returns to ideas as non rivalrous –> unrestricted returns
- Labour and ideas have IRS together
What is the balanced growth path in the Romer model
- No transistion dynamics
- Constant growth rate of all endogenous variable
What is the result of an increase in the population in the Romer model.
Difference between Growth and Level Effects
How does long-term and short-term growth differe in the combined Solow-Romer model
- Long-run growth along balanced growth plan
- Transisiton dynamics if not on BGP.
- Short periods of time, countries can grow at diff. rates
- Long run, countries grow at the same rate
How is the Solow and Romer model combined algebraically
Adding Capital into Romer model w accumulation and investment constraints.
How do you show in the Combined Solow Romer Model that, along the BGP,
G* K = G* Y
What is the growth rate of labour in the COmbined Romow SOlow model
0 as population is a constant
Simplify the combined Romer Solow Model through growth power rules, and get it in terms of g bar
where g bar =z * l * L
What is the consequences that can be drawn from the growth rate in output in the Combined model
Combined model growth rate of output is even larger than in the Romer model
Output higher because:
* Ideas have a direct + indirect effect
* Incresing productivity –> capital stock + output higher
Alongside of the BGP of the Combined model what is the capital:output proportional to
Capital:Output ratio proportional to the investment rate.
What are the consequences of substituting of the results of the capital:output
What does the fact that the combined model has diminishing returns to capital mean for growth when off the BGP
Transistion dynamics apply to both models
- Further below BGP, faster the economy will grow
- Further above the BGP, slower the economy will grow
What is the result of a permanent increase in the investment rate in the Combined Romer model
- BGP of income is higher
- Growth rate higher to reach BGP level.
- Slope of output path steeper than BGP path
What is the result of any change in the parameter of the Combined Romer model
do a)
do b)
answer c) and d)
What is the effect of increasing the research share of labour in the Romer Model
- Growth rate of ideas increases –> growth of GDP per Capita
- Less people working in output, level of output declines –> current consumption declines for increasing future consumption
Creates temp. dip then new steeper BGP
How does the exponent of ideas affect the Romer model
- Theory of sustained growth as together still IRS.
- Eliminates growth effects (perman. changes in rate of growth of GDP per capita) due to diminishing returns
- Only see level effects - changes in absolute value in LR
why is gK* = gY * in the Combined Romer Solow model
g * K is always constant
What shares do TFP and Capital make up the difference between rich countries and poor
What are the 2 viewpoints of allocating investment among capital
- Equalise tax treatment of all types of capital in all industries –> let market allocate to highest marginal product
- Industrial Policy- gov. encourage investment in certain types of capital –> positive externalities
Possible prob w industrial policy?
- Information issues, unable to ‘pick winners’
- Political influence –> picking wrong companies
Fix this by creating right instiutions
What policies can encourage technological progress
- Patents
- Tax incentives for R&D
- Grants for research
- Industrial policy
1.
What is the demographic transistion as countries develop
- Decline in fertility
- Schooling years increase
- Female labour force participation increases
Set up the Model and Resource Constraint for an explanation of changes of the number of kids, consuption and education of kids inn the demographic transisition
a and b are weights
How do you solve the model of the demographic transition (reduced fertility, inc female labour, inc schooling)
- Plug budget constraint in U (c,n,e) function
- Do first order differentiation.
What is structural transformation in the economy
- Economy develops and values added:
- Agricultural sector declines
- Manufacturing first increases than decline
- Services increase
Where is sectoral productivity growth and how does it change per sector
Agricultural sector - higher
Manufacturing - medium
Services - lowest
What is the model for structural transformation + resource constraint.
How do you solve the model for structural transformation
- Equilibrium: production is fully consumed.
- Plug Equilibrium conditions into utility
- Derive optimal choice through first order conditions
Solution implies agricultural productivity increases as labour in agriculture decreases
Answer a)
answer b) and c)
answer d)
answer e) and f)
Answer f) and g)
What are labour market flows and draw a diagram for it
What are the diff. kinds of unemployment
Calculate the NRU and Actual UE
What are the labour market and unemployment equations
How do you find an equation for the natural rate of unemployment
- Solving the model, set change in unemployment to 0.
How do you alter the natural rate of unemployment
- Change the job-finding rate (f)
- Change the job-separation rate (s)
but policies have unintended consequences
What is the steady state and market forces in the labour market
u = U/L = (s/f+s)
- When UE above NRU, market forces push it down
- When UE below NRU, market forces push it up
What are active labour market policies
- Govt. Employment Agencies
- Public job training programmes
- Condition unemployment benefits on job searching
What is Unemployment Insurance (UI)
- pays part of workers former wages for a limitied time after lost of job
Reduces hardship, increases time to find matching job, support AD in recessions
What are the potential problems w UI
- Increase search unemployment –> reduces the opportunity cost of being UE
- Choosing level and duration of UI to find the right balance between cost + balance.
What is Employment Protection Legislation (EPL)
- Policies that make firing workers more costly
e.g. high mandatory severance pay, notice period, severance conditions.
What is the result of EPL on the job finding and separation rate
Ambiguous but should be:
* Lower s - harder to separate job.
* Lower f - harder to find job.
Unemployment persistently higher w strong EPL
Judiciary system enforces and interprets the law.
What is the conflict between insiders and outsiders in politics of EPL
- Unemployment (Insiders) want reduced EPL to help increasing job finding rate.
- Employment (Outsiders) want increased EPL to reduce search rate
What are the Dual Labour markets (permanent and temp. jobs) and what is the result of it.
- UE get work but lack of investment incentive
Temporary job –>
* Middle age workers secure permanent jobs
* Young workers in EU punctuated by brief spells in temp. jobs which don’t build their skills
How does EPL and conflicts impact the wage setting process
- Disprop. weight on interests of insiders. –> reduce job finding and separation rate.
- Wages too high to encourage firms to open vacancies.
- Higher EPL, greater impact of centralised wage setting by insiders
What are payroll taxes and the impact
Increase cost of labour - reduces value of job.
- Fewer vacancies created, hence potentially lower f
What is wage rigidity and what kind of UE does it result it
- Failure of wages to adjust to where Ls=Ld
- Causes structural unemployment
Derive the intertemporal budget constraint (lifetime wealth) with perfect credit markets and taxes.
C + S = Y - T
cons. + savings = income - tax
Draw the diagram of the intertemporal budget constraint with the interceptions and endowment points
What is the result of an increase in current disposable income on the diagram of the intertemporal budget constraint.
- Y0 increases to Y1 results in a sideways parrallel shift of the constraint along current consumption
assump. of c, c’ as normal goods. –> both increase
results in new optimal NE w consumption smoothign
What is the result of an increase in future disposabe income
- Y0’–> Y1’ resukt in parallel shift up along c’
- New optimal w increased c and c’
- Reduced savings
What is the result of an increase in interest rate for a lender
r0–>r1
Price of future consumption (1/1+r) lower, so substitute current for future
Thus c’ increases
c and s dependent on magnitude of income effect
What is the result of an increase in interest rate for a borrower
r0 –> r1
c decreases, s decreases as substitution for future goods works with income
c’ may increase or decrease dep. on magnitude
What is the model for government financing
- 2 periods of spending (G and G’)
- Finance with taxes or debt
- Tax revenue in each period w constant pop. (N)
T=Nt
T’=Nt’
Derive the government budget constraints
let B be savings or debt
What is the competitive equilibrium for consumers, government and the credit market
- Consumers choose c and c’ given IR
- Gov intertemporal budget constraint is satisfied
- Credit market cleared
Derive the Ricardian Equivalence through the Government and Consumer intertemporal budget constraints
- Find Gov. budget constraint in terms of tax (t)
- Plug (t) into consumer constraint (which alr manipulated to taxes form)
- Thus consumption is determined by PDV of G (which determined by t)
POrtray the effect of a tax change in period 1(-x) and increase in future tax in period 2 (x(1+1))
Show the budget constraint doesn’t change for consumers
Draw the effect of the Ricardian Equivalence
Consumer saves for future higher taxes, intemp. budget constraint doesn’t change.
endowment points shifts.
How is the Credit Market impacted with Ricardian equivalence
- Consumers save tax cut (Nx) –> increasing credit quantity
When is Ricardian equivalence not satisfied
Derive the PVC (present value of consumption) from consumption (c), income (y-t) and financial wealth (f)
PVC = financial wealth + human wealth
What is the utility consumption equation
if B=1 –> current and future treated equally.
if B< 1 –> future cons. discounted
Today consumption valued more
How do you choose consumption to maximise Utility
Maximum utility when indifferent between c and c’
Thus derive euler’s equation
How do you solve the Euler’s equation to get it into the form for solving consumption
- Lower B –> impatient, consumption growth lower
- Higher r –> patient, consumption growth faster
r can also be offset by -ve wealth effect
Euler Equation explains growth of consumption is product of discount parameter and interest rate
Solve for c and c’ when B=1
Use Euler’s Equation and the Intertemporal budget constraint
What is the reality of credit markets
IR of borrowing > IR of saving due to assymetric information
Draw different positions of a borrower, lender and endowment point with imperfect credit markets
What is the effect of an increase in the borrowing rate in imperfect credit markets
c goes down
c’ could be either as sub goes up but income goes down
dep on which is stronger
How does Ricardian Equivalence work with imperfect credit markets
- Can’t smooth consumption w imperfect
- Tax cut increases endowment points
- Hence customers choose a new allocation
What is the limited commitment and collateral
- Lenders lack trust
- Thus ask to post collateral
- Borrowing amount fixed by collateral amount
Draw the credit market diagram with collateral
also list the simplifying assumptions
Green point is new endowment due to value of collateral
Collateral point is endowment plus value of house – indicates max amount to be loaned
What happens if p (price per m^2 per second period) goes down in the collateral credit market model
collateral constraint shifts left
endowment point shifts downward
What is the view of consumption as a random walk and permanent-income hypothesis
- Expected changes are planned for due to permanent income hypothesis
- Random walk, - changes should be due to unpredictable events
How does the permanent-income hypothesis hold in reality
Doesn’t always happen:
- Retirement
- Precautionary saving
- Depends on level of wealth
What is the Government budget constraint and how do you get it in terms of Bt
What is the primary and total deficit
- Primary Deficit: Gt - Tt
excluding spending on interest - Total Deficit: i * Bt-1 + Gt - Tt
Diff types of budget balances?
How do you calculate the Debt-GDP ratio from the total deficit
Economic consequences of deficit and debts
- Economic growth
- High inflation or default
- Intergenerational equity
- Crowding out
What is the national income identity
What does the RIcardian equivalence imply out crowding out
- Timing of taxes dont affect consumption
- Thus budget deficits do not crowd out investment
How do you make the debt:gdp ratio, recursive
What are the fiscal problems in the 21st century
Spending + deficits rocketing:
- Aging population
- Age dependency ratio
- Generous entitlement programmes (benefits, pensions, healthcare)
WHat is the problem w social secutiry and healthcare in the US
Baby boomers retiring will boost healthcare expenditure
along with medical tech + wastes
Life consumption not subject to diminishing returns –> increasingly valuable
Thus economic growth cannot help solve the problem of growign healthcare expenditure on its own
