Economic Growth

Question 1

WHat is growth?

Answer 1

The percentage increase in real GDP per annum- or in real GDP per annum per capita

Question 2

What is the equation of motion for K in solow model?

Answer 2

ΔK= s*f(k)-

Question 3

What is the steady state captial stock

Answer 3

when Δk =0

this occurs at one value of k denoted as k*

Question 4

What is the investment equal to

Answer 4

sf(K)

Question 5

What is the golden rule?

Answer 5

Different values of S lead to different steady states

How de we know what the best state is?

The best steady state is when there is the highest possible consumption per person

c*=(1-s)f(k*)

An increase in S

leads to higher K* and y* which raises C*

Reduces consumptions share of income (1-s), which lowers c*

The golden rule level of capital is the steady state value that maximized consumtion

This occurs when MPK=δ

Question 6

What are the implications of the Solow Method?

Answer 6

• The Solow growth model predicts – among other things – that in the long run a country’s standard of living depends positively on its saving rate.
• At any moment the capital stock is a key determinant of the economy’s output but the capital stock can change and this can lead to economic growth.
• If the savings rate is high the economy the economy will have a large capital stock and a high level of output but if the saving rate is low, the economy will have a small capital stock and a low level of output.
• Higher savings lead to faster growth - but only temporarily: an increase in the rate of saving raises growth until the economy reaches the new steady state

The Solow model also predicts that countries with higher population growth rates will have lower levels of capital and income per worker in the long run.

• In addition, it asserts that poor countries will grow more quickly than average, while rich countries will grow more slowly than average. – i.e. poor countries should ‘catch up’
• But social and political differences may enable some economies to catch up more effectively than others.
• Mixed empirical evidence on the ‘catch up’ hypothesis

Question 7

What are the key assumption so the Solow model?

Answer 7

Aggregate output can be represented by a production function

• There are no ‘inefficiencies’ or ‘aggregate demand failures’
• Full employment
• The aggregate production function displays decreasing returns to any single factor
• Technology is exogenous, i.e. cant be changed by government policy, new tech comes when you arent expecting it
• Constant returns to scale
• Capital and Labour are homogenous and substitutable with one another

Question 8

What is endogenous Growth Theory?

Answer 8

• Externalities to capital: – Higher capital in one firm increases productivity in other firms.
• ‘Endogenous’ growth theory because it suggests that growth may depend on parameters that can be influenced by private behaviour or public policy
• Growth can be sustained through gains from knowledge externalities or targeted investments in technological progress (e.g. firms should invest in R&D and governments should subsidise human and physical capital formation)

Question 9

How do you increase the savings rate?

Answer 9

Reduce the government budget deficit (or increase the budget surplus).

• Increase incentives for private saving:

– Reduce capital gains tax, corporate income tax, estate tax, as they discourage saving.

– Replace income tax with a consumption tax.

– Expand tax incentives for individual retirement accounts and other retirement savings accounts.

Question 10

What are the three main types of capital?

Answer 10

– private capital stock

– public infrastructure

– human capital: the knowledge and skills that workers acquire through education

Question 11

What are the two viepoints on how to allocate investment in the economy? and what are their problems?

Answer 11

Equalize tax treatment of all types of capital in all industries, then let the market allocate investment to the type with the highest marginal product. Problem: the market may follow short-term objectives

2. Industrial policy: Govt should actively encourage investment in capital of certain types or in certain industries because they may have positive externalities that private investors don’t consider. Problem: the govt may not have the ability to “pick winners” (choose industries with the highest return to capital or biggest externalities) and political influences may interfere

Question 12

How can technoligical progress be encouraged?

Answer 12

Patent laws: encourage innovation by granting temporary monopolies to inventors of new products.

• Tax incentives for R&D
• Grants to fund basic research at universities
• Industrial policy: encourages specific industries that are key for rapid technological progress (subject to the preceding concerns)