Lectures 5 and 6 - From stagnation to sustained economic growth

Question 1

How was sustained economic growth achieved post 1750?

Answer 1

• The emergence of sustained economic growth was associated with a large transition of the labour force out of agriculture and into manufacturing and services
• Such transition implied a massive rural-urban migration

Question 2

What does the symbol y* represent?

Answer 2

y* is a measure of average income in the economy

Question 3

What are the two main groups of people in a traditional economy?

Answer 3

Workers: Only their own labour
Landlords: Own a piece of land and their own labour

Question 4

Explain the differences in income for workers and landlords in a traditional economy

Answer 4

• Workers only get a wage as income
• Landlords get a wage and the rent on land

Question 5

If worker Bill left his job working for landlord Mr Jones, how much would production decrease by?

Answer 5

If worker Bill leaves his job working for landlord Mr Jones, production would decrease by the marginal product of labour (MPL)

Question 6

Derive an expression to show the decrease in production when a worker leaves their job working for a landlord in a traditional economy

Answer 6

dY/dL = dAX^βL^1-β/dL = (1-β)AX^βL^-β = MPL

Question 7

If worker Bill leaves his job working for landlord Mr Jones, what is the loss to Mr Jones equal to and how does this link to the maximum wage that Mr Jones is willing to pay to Bill?

Answer 7

• The loss to Mr Jones if Bill leaves is equal to the MPL
• Therefore, the MPL is equal to the maximum wage that Mr Jones is willing to pay to Bill

Question 8

If there are competing landlords in a traditional economy, what is the exact wage a landlord will pay their employees?

Answer 8

If there are competing landlords in a traditional economy then the exact wage paid to workers is equal to the MPL

Question 9

Use contradiction to show that the exact wage received by workers in a traditional economy with competing landlords is equal to the MPL

Answer 9

Suppose that a worker is currently receiving wage w<MPL from landlord 1:
- A second landlord could offer the worker wage w’ with w<w’<MPL
- Landlord 2 is happy since the worker costs less than he is worth (w’<MPL)
- The worker is also happy as landlord 2 pays more than landlord 1 (w<w’)
- The only way that landlord 1 can prevent the worker from leaving is by paying w=MPL

Question 10

What wage do employers pay to workers in a competitive labour market?

Answer 10

If employers are in competition with one another to recruit labour, then workers get paid a wage equal to the marginal product of labour (w=MPL)

Question 11

Derive an expression for w which is the wage a worker gets paid in a competitive labour market in its simplest form

Answer 11

• w= MPL = dY/dL = dAX^βL^1-β/dL = (1-β)AX^βL^-β
• But y = AX^βL^-β so w = (1-β)y
• But since we are in equilibrium (y=y), w = (1-β)y

Question 12

What is the expression for the wage paid to workers in a competitive labour market?

Answer 12

w = (1-β)y*

Question 13

What does the wage earnt by workers given by w = (1-β)y* tell us?

Answer 13

This tells us that wage earners like Bill earn less than GDP per capita

Question 14

In a traditional economy are wages constant in equilibrium?

Answer 14

As wages are given by w = (1-β)y, since y is constant over time wages are constant in equilbrium

Question 15

Who is the extended Malthusian model which includes a modern sector (manufacturing) as well as the traditional sector (agriculture) due to?

Answer 15

The extended Malthusian model that includes a modern sector is due to Hansen and Prescott (2002)

Question 16

State the two sector model for both a traditional and a modern economy

Answer 16

T and M are subscripts:
- Y = YT + YM
where:
- YT = AX^βLT^1-β
- YM = ALM
- L = LT + LM

Question 17

What is the key difference between the traditional sector and the modern sector?

Answer 17

• Key difference: While GDP is concave in labour in the traditional sector, in the modern sector it is linear
• This means that in the traditional sector the additional contribution of extra labour is lower the more labour there already is whereas in the modern sector the additional contribution of extra labour is the same no matter how much labour there already is

Question 18

What is the maximum wage an entrepreneur is willing to pay workers in the modern sector and derive an equation for this

Answer 18

• In the modern sector, the maximum wage an entrepreneur is willing to pay a worker is the marginal product of labour in the modern sector
• dYM/dLM = dALM/dLM = A = MPLM

Question 19

If there are multiple entrepreneurs that a worker can work for in a modern economy, what will the wage paid to the worker be equal to?

Answer 19

wM = MPLM = A (MPL in the modern sector)

Question 20

State the expressions which give the wages earnt by workers in both a traditional and a modern economy

Answer 20

• Traditional wage: wT = (1-β)y* where y* is constant over time
• Modern wage: wM = A where A is growing at a constant rate since g^A > 0

Question 21

Explain why workers chose to move to the modern sector from the traditional sector in terms of their wages

Answer 21

• As the current wages in the modern sector are wM = A and A is growing at a constant rate clearly there will come a year where A = (1-β)y*
• Before 1770 it is true that wT > wM so all workers will stay in the traditional sector
• After 1770 A > (1-β)y* so wT < wM therefore all the workers will want to move to the traditional sector so the economy will begin to transform

Question 22

Why is the movement of workers from the traditional sector to the modern sector gradual?

Answer 22

• Once the modern sector wage exceeds the traditional sector wage workers begin to move from the traditional sector to the modern sector
• As the workers move out, the traditional sector wage increases to match the modern sector wage as the same demand meets decreasing supply
• This process keeps on continuing as both wages increase

Question 23

Does GDP per capita depend on population size in both a traditional and a modern economy?

Answer 23

• In a traditional economy, GDP per capita does depend on the population size (y depends on L)
• In a modern economy GDP per capita does not depend on the population size (y does not depend on L)

Question 24

Derive the long-term equilibrium equation of growth for a modern economy

Answer 24

• y = Y/L = AL/L = A
• g = y˙/y = A˙/A = g^A
  Therefore:
  gM = g^A > 0

Question 25

Explain how the economy changes from traditional to modern over time as wages in both sectors change

Answer 25

1- A < Ā: the economy is fully traditional and g=0
2- A > Ā, early stages: As modern sector begins to matter, g starts to increase
3- A > Ā, later stages: As the economy converges to fully modern, g converges to g^A

Question 26

Why has sustained economic growth only emerged after 1750?

Answer 26

• In the era of stagnation, economies were mostly traditional. In that environment, technological progress did not lead to sustained economic growth since it was constantly offset by population growth
• In the late 18th century technology became sophisticated enough and workers started to move into the modern sector. In the modern sector technological progress does lead to sustained economic growth because it is not offset by population growth

Question 27

What was the event that first marked the achievement of sustained economic growth?

Answer 27

The British Industrial Revolution was the first event that marked the emergence of sustained economic growth

Question 28

Why was the British Industrial Revolution the first event to display sustained economic growth?

Answer 28

• Structural transformation started much earlier in Britain than anywhere else
• This was due to the fact that A increased in Britain much more than anywhere else

Question 29

What were some of the drivers of the technological progress in the British Industrial Revolution and give some examples of the inventions made during this era

Answer 29

• The roots of the industrial revolution were a series of brilliant inventions made in 18th century Britain such as the steam engine and machines for the production of cotton textiles

Question 30

What invention was the backbone of the British Industrial Revolution?

Answer 30

• Newcomen’s steam engine which was invented in early 1700 was the backbone of the industrial revolution
• As improved by James Watt in the late 1700s, it revolutionised the way in which production took place. It was used in mines, factories and transportation