Long Run Model

Question 1

Reminder of MPL and MPK in CD form

Answer 1

MPL= vY/L
MPK= (1-v)Y/K

Question 2

Now what is the formula for share of income going to labour?

Answer 2

(MPL X L)/Y = (vY/L x L)/Y = v

So share of income going to labour is just v!!
(From CD function AL to the v K to the 1-v)

Question 3

Now what is the formula for share of income going to capital?

Answer 3

(MPK X K)/Y = ((1-v)Y/K x K)/Y = (1-v)

So basically share of income going to labour or capital is just the powers of the CD function!

Question 4

Use of v

Answer 4

As long as v is constant overtime, so is the share of income going to capital and labour. In UK v is approx 0.75 US 0.7

Question 5

Factors influencing how income share is determined (3)

Answer 5

Tech change (substitution to robots)
Firms/trade unions bargaining power
Tax system

Question 6

What is national saving determined by in SR vs LR?

Answer 6

Short run- government (tax/expenditure decisions)
Long run- household decisions

E.g G spend more, Sn falls, r rises. (Crowding out)

Question 7

The role of government in national savings

Answer 7

If government spend more, NS falls, interest rates rise.

(Exp prevalent in short run national saving where variations are dependent on tax/exp decisions)

Question 8

What historical episodes are associated with high government spending

Answer 8

Wars - high spending during wars. Creating high interest rates

Question 9

Global savings rates are high now, making interest rates very low.

How to combat this? and 2 evaluations, and evaluation of first eval.

Answer 9

Run fiscal deficits (G>T) to reduce national saving and increase interest rates again.

Eval:
1.high interest reduces investment.
2.fiscal deficits contribute to inflation and thus cause uncertainty and reduce investment.

Eval to first eval: this is more productive as only higher return projects chosen.

Question 10

2 evaluations of fiscal deficits (covered last slide)

Answer 10

Higher interest reduces investment
Spending on fiscal deficit contributes to high inflation and uncertainty (reduced investment again)

Question 11

Impact of trade restrictions in the long run in a SMALL OPEN ECONOMY (protectionist policies)

Answer 11

Use FEM model
1. Protectionist policies raise demand for net exports (shift in NX)

2. Appreciation in exchange rate
3. But leave net exports unchanged

Question 12

Trade restrictions in the long run in a LARGE OPEN ECONOMY

Answer 12

FEM - Protectionist policies raise demand for net exports (shift in NX). Appreciation in exchange rate, but net exports unchanged.

Same result as small open economy

Question 13

Why has the US been running a large trade deficit?

Answer 13

Sn - I<0 which means CF and NX<0 , so has to borrow (capital inflows) to fund its domestic spending.

Question 14

Where should capital flow to?

Answer 14

Where K/N (capital per labour) is low since MPK is high.

Question 15

Why do capital flows not necessarily go to these developing countries where K/N (capital per worker) is low? (4)

Answer 15

Production conditions are different (capital doesnt fit with production techniques)

Human capital is lower so capital can’t be used properly

Poor legal systems that do not product producers

Corruption and expropriation