Growth & Model of Production

Question 1

5 positives of GDP as a measure

Answer 1

1. easy comparison across time and countries
2. objective and direct
3. natural metric = money
4. increased productive capacity affects healthcare & other welfare related aspects
5. Strongly +VE correlated with direct measures of well-being

Question 2

4 issues with GDP

Answer 2

1. income inequality
2. more vs less educated workers
3. urban vs rural
4. externalities

Question 3

3 steps for macroeconomists

Answer 3

1. document facts
2. build model to explain facts
3. examine model effectiveness

Question 4

Model =

Answer 4

a mathematical representation of a hypothetical world that we use to study economic phenomena.

Question 5

Production functions shows

Answer 5

How much output can be produced with a given number of inputs.

Question 6

production function =

Answer 6

Y = F(K, L) = A bar K^a L^(1-a)

Question 7

change in Y due to (3)

Answer 7

1. change in capital stock
2. change in labour
3. change in efficiency of production

Question 8

3 properties of cobb-douglas production fucntion

Answer 8

1. Increasing in both inputs
2. Decreasing MPK&MPL = concave
3. CRS

Question 9

Argument for CRS

Answer 9

Replication argument: if all factors duplicate, we can set up an identical copy of the production process = output doubled.

Question 10

Under CRS, how can we express output per worker?

Answer 10

Y/L = F(K/L, L/L) = F(K/L, 1)
y = f(k)

Question 11

What value does alpha take? Why?

Answer 11

alpha = capital share of income = 1/3 in data

1 - alpha = 2/3 = labour share of income

Question 12

Representative firm problem

Answer 12

MAX Pi = F(K, L) - wL - rK

Question 13

What do we assume about price of output?

Answer 13

Normalise price to 1

Question 14

Markets are…

Answer 14

perfectly competitive so w and r are taken as given by a firm.

Question 15

K hiring rule

Answer 15

MPK = r
alpha A bar (L/K)^1-a = r
alpha (Y/K) = r

Question 16

L hiring rule

Answer 16

MPL = w
(1-alpha) A bar (K/L)^a = w
(1-alpha) (Y/L) = w

Question 17

What do we assume about supply of factors?

Answer 17

K = K bar
L = L bar
supply fixed and exogenous

Question 18

5 endogenous variables

Answer 18

Y, L, K, w, r

Question 19

5 equations

Answer 19

1. production function
2. Hiring K rule
3. Hiring L rule:
4. K market clears: K = K bar
5. L market clears: L = L bar

Question 20

5 solutions to our GE

Answer 20

Y* = A bar K bar^a L bar^1-a
L* = L bar
K* = K bar
r* = alpha Y*/K* = alpha A bar L/K ^2/3
w* = (1-alpha) Y*/L* = (1-a) A bar K/L ^1/3

Question 21

Link between K and L markets

Answer 21

Supply of K affects wage rate (and supply of L affects rental rate)

Question 22

Profits in GE

Answer 22

Zero profits in perfect competition
All income paid as remuneration to K and L
rK + wL = Y*

Question 23

What does developing accounting try to do?

Answer 23

Use postulated production function to account for cross-country differences in GDP.

Question 24

2 assumptions for developing accounting

Answer 24

1. alpha same for all countries = 1/3

2. set A bar = 1 for all countries

Question 25

Outcomes of developing accounting exercise - is this model any good?

Answer 25

Model over-predicts other countries’ GDP as proportion of USA’s. SO model relying only on change in K = under-predicts cross-country gaps in GDP.

Question 26

Is it realistic to assume A bar = 1 for all countries?

Answer 26

NO - in reality A bar differs wildly

Question 27

How much of cross-country GDP differences does capital per person explain?

Answer 27

1/3

Question 28

How much of cross-country GDP differences does TFP explain?

Answer 28

2/3

Question 29

So rich countries are richer due to… (2)

Answer 29

1. More K per person

2. More importantly, use K and L more efficiently.

Question 30

Main interpretation of TFP =

Answer 30

technology - tech innovation/adoption

Question 31

2 other explanations of TFP

Answer 31

Human K - education and skills

Institutions