Economic growth and public policy

Question 1

What is the importance of saving and investment?

Answer 1

• Investment is necessary to sustain + increase capital stock
• Large amount of current investment in capital goods = raised production in the LR

Question 2

The law of diminishing returns

Answer 2

-If savings rate increases then fewer resources are needed to make consumption goods, capital good production increases and so does GDP
-But as the stock of capital rises additional output falls
meaning an increases in saving only promotes growth in the SR

Question 3

The catch-up effect

Answer 3

“It is easier for a country to grow fast if it starts relatively poor” (Solow model of economic growth)

• In poor countries, minor investment will have a huge impact on production
• But as sustained higher investment means the ratio of capital to labour goes up but the marginal product of additional units of capital will decline
• A ‘steady-state growth path’ is reached when output, capital and labour are all growing at the same rate

Question 4

Define foreign direct investment

Answer 4

= Capital investment owned and operated by a foreign entity

- eg. A foreign company opening up a factory here

Question 5

Define foreign portfolio investment

Answer 5

= Monetary investment from abroad in the form of shares or equity

Question 6

The importance of investment from abroad?

Answer 6

• Provides resources necessary to increase stock of capital = higher productivity
• Raises GDP
• The world bank uses money generated by developed economies to lend to poor countries for the development of infrastructure

Question 7

The importance of education?

Answer 7

= An investment in human capital

• In developed economies, each extra yr of schooling raises income by 10%
• Creates positive externalities eg. ideas to increase productivity
• Many developing countries suffer from a “brain drain”

Question 8

The importance of health and nutrition?

Answer 8

• Investments in a nation’s health by gov’t will increase production
• Hard to escape the cycle of poor health = low wealth

Question 9

The importance of property rights, political stability, and good governance

Answer 9

• Effective allocation of resources will increase productivity, the economy coordinates this through market prices
• Property rights ensure the company producing a product gains the benefits from it otherwise they would have no incentive to produce
• Corruption discourages investment from abroad
• Political instability discourages saving and the starting of new businesses

Question 10

The importance of free trade?

Answer 10

• Attempts to promote economic growth by imposing high tariffs and trade restrictions are not the most effective way to increase productivity
• Trade is in a way a form of technology which turns one good into another, by imposing barriers to this a country misses out on the advantages of specialisation and technology

Question 11

The importance of R+D?

Answer 11

= Knowledge is technically a public good and thus the gov’t has a responsibility to encourage R+D into new technologies
- Could be in the form of funding/grants, tax breaks or the patent system

Question 12

The importance of population growth?

Answer 12

Larger population = more workers and consumers

• With population growth, we have also achieved growth in technologies, knowledge, and production
• But high population growth can be seen as “diluting the capital stock” as it reduces GDP and capital pp eg. strained education system
• Large population increases probability of new ideas but in developed economies most ideas have already been utilized and in developing ones people do not that the resources available to capitalize on them