Economic Growth L13+14

Question 1

What is technological knowledge in terms of L and K?

Answer 1

The use of combinations of the two to produce output

Question 2

Why is the classical model unable to explain the economy’s LR trend in growth?

Answer 2

Because:

Y = F,(L,K) - all are fixed in classical tf doesn’t explain increasing Y

Question 3

What does the Solow model explain?

Answer 3

How growth in L, K and technological knowledge affect an economy’s total output

Question 4

Show how you get the demand per worker equation y=c+i?

Answer 4

Now

G and C become joined since both are used immediately

Question 5

Show how you get the supply per worker equation y=f(k)?

Answer 5

Now

Question 6

What is the saving rate?

Answer 6

The fraction of income saved (Solow model assumes constant)

Question 7

Explain how changes in capital shift the LRAS right?

Answer 7

Since y=f(k)

Δcapital implies Δoutput

Tf

Δcapital over time implies Δoutput over time

Question 8

2 factors that influence capital?

Answer 8

Investment (causes increase in k)

Depreciation (causes decrease in k)

Question 9

Yearly capital depreciation = ?

Answer 9

δk

Question 10

Derive the Solow model equation?

Answer 10

Now

Question 11

What does the Solow model show?

Answer 11

Changes in capital are crucially influenced by the saving rate

Question 12

Draw diagram showing the curves of output and investment? Why are they like this?

Answer 12

Investment curve sf(k) represents the part of output that is used for saving(=i)

Both curves have diminishing returns on capital per worker wrt output

Question 13

Draw diagram showing the steady state of depreciation and investment? What happens beyond and before the steady state?

Answer 13

Beyond: depreciation>investment tf negative Δk(capital/worker)

Before: investment>depreciation tf positive Δk

Why? Solow model equation

Question 14

Why is the depreciation line straight?

Answer 14

Because as capital increases, the total amount of capital that depreciates also increases

Question 15

Why does the steady state occur?

Answer 15

When k=k*

Tf when sf(k)=δk

Question 16

Due to diminishing returns, the smaller the initial value of k,…? (2)

Answer 16

The greater the effect of Δk on the increase in output will be

Tf all other things being equal, it is easier for a country to grow faster if it starts relatively poor (CATCH UP EFFECT)

Question 17

How does the saving rate affect the steady state? How does a country with a higher saving rate look on the diagram?

Answer 17

The higher the saving rate (s), the higher the k* tf countries with higher saving rates have higher income

Line starts at 0 still but ends higher up (diminishing returns are slower to come about)

Question 18

What is the slope of the f(k) line?

Answer 18

The marginal physical product of capital

Question 19

When finding the optimum saving rate, why shouldn’t we aim to maximise income?

Answer 19

Because if we use s=1 (required to maximise income):

c=(1-s)y tf c=0y=0 - zero consumption level is bad!

Question 20

Why can’t we maximise consumption when looking for optimal saving rate?

Answer 20

Spending all income on c means s=0:

Tf i=sf(k)=0 tf all capital will depreciate

Question 21

How does the golden rule suggest we find the optimum saving rate?

Answer 21

To find steady state k* that is optimal, we have to compare consumption at different steady states

Question 22

Where is the golden rule level of capital? Show on a diagram this?

Answer 22

When the distance between f(k) and δk is maximised, consumption is maximised whilst in a steady state, therefore the government will choose whatever saving rate this occurs at (if they could)

Question 23

When is the golden rule of capital reached (equation) ?

Answer 23

MP(k*)=δ

Question 24

When is the golden rule of capital reached (graphically)?

Answer 24

When the slopes of f(k) and δk are the same and equal to δ

Question 25

See transition and page 11L14 for diagram of y,c,i against time

Answer 25

Reminder: i in all of this is investment/worked

Question 26

What happens as the saving rate is changed to reach GR?

Answer 26

There is a short term fall in C (see diagram for why)