midterm - unit 2

Question 1

An interesting and somewhat surprising, empirical observation is that the US output-capital ratio has been relatively constant over the course of time how is this possible even though/if the marginal product of capital (MPK) is decreasing?

Answer 1

-Typically the marginal product of capital should decrease when more capital is amassed, and this is because of the diminishing law of returns.
-Even though this is usually true there are some factors which can explain the observation that the US output-capital ratio has been relatively constant over the course of time.
-Technology is a major factor in explaining this because, as technology has advanced productivity has increased meaning the more output can be produced with the same amount of capital.
-The advancement of technology has also increased the amount of capital that has been gained over the years.

Question 2

The invention of capital during the industrial revolution and 200 years of capital accumulation since then have led to great increases in per-capita output. In 1987, Robert Solow won the nobel prize for giving us hope that said growth might continue forever. State and elaborate on the crucial difference between capital and land that might permit us to grow forever

Answer 2

-The main difference between land and capital that might permit us to grow forever is in their differences in their potential for growth and productivity.
-For starters Capital talks about man made resources, these are things that can continue to be manufactured and improved upon over time.
-Land is a limited resource that cannot be extended and takes hard work to maintain or replace if damaged.
-For capital the invention of new technologies will contribute to it’s growth and advancement, and improve upon what has already been made.
-For land, technology cannot change the fact that land is a limited resource like it can with capital.
-Due to these differences the potential for growth comes from the ability of capital to be constantly innovating.

Question 3

Give an example of a negative shock to aggregate demand. Holding long run aggregate supply fixed, what happens to equilibrium output and the equilibrium price level following such a shock? Be sure to distinguish between the short and the long run.

Answer 3

-An example of a negative shock to aggregate demand would be a financial crisis like the Great Depression which caused a large increase in consumer spending.
-In the short run the negative shock to aggregate demand would lead to a decrease in equilibrium output and a decrease in the equilibrium price level.
-With a decreased aggregate demand firms produce less, which leads to higher unemployment.
-In the long run the firms can change their prices they could also change how they go about their production, and they may end up getting to a new equilibrium point just at a lower output.

Question 4

The rule of 70

Answer 4

Approximates how long it will take for the size of an economy to double
TO CALCULATE:
- (70)/(growth rate in percent)

Question 5

Which factor of production explains the lack of cross country convergence

Answer 5

Labor

Question 6

Technology and TFP

Answer 6

Technology is arguably the major driver of a country’s per capita output

Question 7

TFP: Patents

Answer 7

Patents as a measure of output of the process of technological advancement

Question 8

Malthus growth assumptions

Answer 8

1. aside from labor, the main factor of production is land
2. everything that is produced is consumed
3. higher levels of consumption lead to increased fertility

Question 9

Malthus growth result

Answer 9

-his key prediction said that technological advancement does not lead to sustained improvements in quality of life
-this is because when technology improves, any positive effects are offset by a decrease in land per capita

Question 10

Malthus growth implication

Answer 10

since finite resources must be shared among a country’s population, having more people is bad (for everyone’s quality of life)

Question 11

Solow growth assumptions

Answer 11

1. aside from labor, the main factors of production are capital and technology
2. each period, a country must decide what fraction of output to consume and what fraction of output to save in the form of capital investment
3. higher levels of savings lead to faster growth in the capital stock
4. technology continually improves each period

Question 12

Solow growth result

Answer 12

-technological advancement does lead to sustained improvements in quality of life
-this is because when technology improves, increased saving leads to a higher capital stock, which allows for a higher level of output/consumption
-per capita capital, output, and consumption rise with technology without any sort of upper bound

Question 13

Solow growth implications

Answer 13

the combination of capital accumulation and continued technological advancement is sufficient for us to essentially grow forever

Question 14

Growth limitations

Answer 14

1. depletion of natural resources
2. negative effects on the environment more broadly
3. diminishment of distinctive cultures (also trade)

Question 15

Types of recessions

Answer 15

1. simple/algorithmic
   -two consecutive quarters of decline in a country’s real GDP
2. actual/holistic
   -a significant decline in economic activity that is spread across the economy and that lasts more than a few months

Question 16

Business cycles: cyclicality

Answer 16

-procyclical: correlates positively with real GDP
-countrcyclical: correlates negatively with real GDP
-acyclical: exhinits no correlation with real GDP

Question 17

Business cycles: timing

Answer 17

-leading: timing of cycle precedes real GDP
-lagging: timing of cycle follows real GDP
-coincident: timing of cycle mirrors real GDP

Question 18

Recession causes

Answer 18

1. financial crises
2. monetary crises
3. public health crises

Question 19

Aggregate Supply: Long run

Answer 19

-nominal factor costs are not fixed in the long run
-as factor costs adjust, aggregate supply is independent of price level

Question 20

Demand shock: Negative

Answer 20

-in the short run wages and costs are rigid, the decreased price level causes a recession
-Temporary: as demand recovers price and output return to original levels
-Permanent: Factor prices adjust to the new price level, which shifts to the right

Question 21

Demand shock: Positive

Answer 21

-in the short tun wages and input costs are rigid, the increased price level causes a boom
-Temporary: as demand retreats output and price level return to original level
-Permanent: factor prices adjust to the new price level which shifts to the left

Question 22

Supply shock: negative

Answer 22

-in the short run decreased production causes inflation
-as supply recovers output and price return to their original level

Question 23

Supply shock: positive

Answer 23

-in the short run increased production causes deflation
-as supply retreats output and price return to their original level

Question 24

Demand deficient vs supply deficient recessions

Answer 24

Demand:
-the price is experiencing downward pressure
-monetary and/or fiscal policy can be used to shift aggregate demand back to the right

Supply:
-the price level is already experiencing upward pressure
-policy makers decide whether to prioritize output/ employment or prices

Question 25

During the second half of the 20th century, Soviet Russia experienced relatively little economic growth despite substantial investment into its capital stock. With reference to its marginal product of capital, why did Russia not grow faster?

Answer 25

-Just investing in capital stock will not contribute to large economic growth without the presence of technological advancements
-Specifically regarding the marginal product of capital, their inefficient allocation or resources meant that they did not get the best returns, this lead to stagnant growth

Question 26

Even though the Malthus model does not serve as a workhorse model of modern economic growth, it is nevertheless useful to some extent. Describe in which sense the Malthus model may be described as useful.

Answer 26

-Assumes that everything that is produced is consumed
-says that higher levels of consumption lead to increased fertility
-offers insights into historical patters of population and resource dynamics
-serves as a reminder of how important technological advancements are (especially when talking about resource scarcity)

Question 27

Empirical evidence suggests that, sometimes, inflation is procyclical, whereas at other times it is countercyclical. Referencing out AD-AS model, provide an economic argument as to why this would be the case.

Answer 27

-In the AD-AS model, inflation is either procyclical or countercyclical depending on the movement of aggregate demand and aggregate supply during different phases of the business cycle

-for procyclical inflation, during periods of expansion (boom) aggregate demand tends to increase when comsumer confidence increases, which leads to spending.
-This can outpace the ability for aggregate supply (AS) to respond quickly, which causes upward pressure on prices due to increased demand, so inflation is procyclical in booms

-For countercyclical inflation, during economic downturns (recession), aggregate demand (AD) tends to decrease as consumer spending declines
-this can lead to excess capacity and unemployment, which causes prices to decrease because of demand being weaker than supply. inflation is countercyclical in recession

Question 28

Most macroeconomists believe aggregate demand to be decreasing in the overall price level. Describe one of three stories referenced in class as to why aggregate demand falls when prices rise

Answer 28

-During the covid recession, we saw aggregate demand fall despite there being rises in some prices
-the pandemic disrupted supply chains and reduced capacity, certain goods and services experienced scarcity which led to an increase of price (ex: PPE)
-When prices rose in these areas consumers had less income to spend elsewhere which led to a decrease in overall aggregate demand
-the uncertainty surrounding the pandemic had people saving more which further lowered aggregate demand

Question 29

The economic effects of a recession are likely to have the biggest impact on the sales of which of the following businesses?

a.) a grocery store
b.) a furniture store
c.) a fast food restaurant

Answer 29

b.) a furniture store

Question 30

In our AD-AS model, aggregate supply (AS) is upward sloping in the _____, but vertical in the ______. This is because factor costs tend to be ______ in the short run, but ______ in the long run.

a.) short run, long run, sticky, flexible
b.) short run, long run, flexible, sticky
c.) long run, short run, sticky, flexible
d.) long run, short run, flexible, sticky

Answer 30

a.) short run, long run, sticky, flexible

Question 31

A key reason why economists view aggregate demand as downward sloping is that they believe the real interest rate to be ____ the price level

a.) increasing in
b.) decreasing in
c.) unresponsive to

Answer 31

a.) increasing in

Question 32

The National Bureau of Economic Research (NBER) defines a recession as

a.) two consecutive quarters of declining real GDP
b.) two consecutive quarters of declining nominal GDP
c.) a significant decline in economic activity that is spread across the economy and that lasts more than a few months
d.) a significant decline in inflation and unemployment lasting more than a few months

Answer 32

c.) a significant decline in economic activity that is spread across the economy and that lasts more than a few months