Long-run economic growth

Question 1

What is the Convergence hypothesis?

Answer 1

The big gap in Y between developed and developing countries become smaller over time

Question 2

What is the Divergence hypothesis?

Answer 2

The big gap in Y between developed and developing countries becomes wider over time

Question 3

What is Economic Growth?

Answer 3

% change in income per capita

Question 4

What is Economic development?

Answer 4

Economic growth + institutional or structural aspects

Question 5

What are the two engines of economic growth?

Answer 5

Investment
Productivity

Question 6

What is the growth accounting equation?

Answer 6

Y’ = A’ + akK + anN

Question 7

What happens to the growth accounting equation when an approached 0?

Answer 7

Y’ = A’ + ak*K
=> Technological progress and investment lead to economic growth

Question 8

What is Solow Residual?

Answer 8

A’ = Y’ - ak*K
=> Measure of the portion of output growth that cannot be explained by the growth in input factors such as labor and capital

Question 9

What are the implications of the Solow Growth model?

Answer 9

y = f(k)

i) Capital accumulation leads to economic growth up to a certain level
ii) Economic growth slowdown is due to diminishing MPk
iii) Technical progress (from A to A’) can make economic growth forever

Question 10

What are the 3 important assumptions in the Solow Growth Model?

Answer 10

i) Production function: Y=A+f(K, N)
ii) Diminishing MPk
iii) Constant return to scale

Question 11

What is the equation leading to the Golden rule capital-labor ratio maximizing the welfare?

Answer 11

i = (n+d)k
Y = C + I
C = Y - I = Y - (n+d)K
At the steady state, y, c, and i are constant
c = y - (n+d)k = Af(k) - (n+d)k

We choose k* (golden rule capital-labor ratio) to maximize the welfare

Question 12

What are the 4 implications of the golden rule capital-labor ratio equation?

Answer 12

i) Actual k < k* in every country
ii) Larger k leads to larger c
iii) If k=max, then c=0. as k increases, all outputs are used for investment and c=0
iv) Productivity growth: when A*f(k) increases, c increases

Question 13

What is the best way to rise y and c?

Answer 13

Productivity improvement

Question 14

What are the strength of Solow Growth Model?

Answer 14

• The first rigorous economic growth model
• Influenced a lot of economic growth models

Question 15

What are the limits of Solow Growth Model?

Answer 15

• ignore institutional factors
• do not explain the determinants of productivity
• ignore the existence of unemployment
• ignore the open economy

Question 16

What is an exogenous variable?

Answer 16

A variable that is taken as given

Question 17

What is an endogenous variable?

Answer 17

A variable that is determines by the equilibrium in the model