Reading 15 - Economic Growth and the Investment Decision

Question 1

What are the factors that influence both the growth of GDP and the level of GDP?

Answer 1

1. Savings & Investment
2. Financial Markets and Intermediaries
3. Political stability, rule of law, and property rights
4. Investment in human capital
5. Tax and regulatory systems
6. Free trade an unconstricted capital flows

Question 2

What is the formula to calculate the Cobb-Douglas Production function?

Answer 2

Question 3

What is the overall conclusion of the Cobb-Douglas production function?

Answer 3

States that output (GDP) is a function of labor and capital inputs and their productivity

Question 4

Extrapolating on the Cobb-Douglas production function, how is the output per worker (Y/L) calculated?

Answer 4

Question 5

Describe what capital deepening is ?

Answer 5

That increases in output can be gained by increasing capital per worker

Question 6

What is the “Dutch Disease” ?

Answer 6

The situation where global demand for a country’s natural resources drives up the country’s currency values, making all exports more expensive and rendering other domestic industries uncompetitive in the global markets

Question 7

What is the quantity of labor?

Answer 7

is defined as the size of the labor force multiplied by the average hours worked.

Question 8

What is the labor force?

Answer 8

Is defined as the number of working age (ages 16-64) people available to work, both employed and unemployed

Question 9

What are the Labor Supply factors that effect economic growth?

Answer 9

1. Demographics
2. Labor force participation
3. Immigration
4. Average hours worked

Question 10

How is labor force participation calculated?

Answer 10

= Labor force / working age population

Question 11

Investment in these 3 factors can affect economic growth…..

Answer 11

1. Human Capital
2. Physical Capital
3. Technological development

Question 12

What are the 3 theories of economic growth ?

Answer 12

1. Classic growth theory
2. Neoclassical theory
3. Endogenous growth theory

Question 13

Describe the Classical Growth Theory….

Answer 13

Growth in real GDP per capita is temporary - when the GDP per capita rises above the subsistence level, a population explosion occurs and GDP per capita is driven back to the subsistence level

**This theory is not supported by empirical evidence

Question 14

Describe the Neoclassical growth theory…..

Answer 14

It contends that the sustainable growth rate of an economy is a function of population growth, labor’s share of income, and the rate of technological advancement.

Growth from savings is only temporary.

Its primary focus is on estimating the economy’s long term steady growth rate

Question 15

Describe the Endogenous growth theory…….

Answer 15

It contends that technological growth emerges as a result of investment in both physical and human capital

Question 16

What is absolute convergence hypothesis?

Answer 16

States that less developed countries will achieve equal living standards over time

Question 17

What is the conditional convergence theory?

Answer 17

States that convergence in living standards will only occur for countries with the same saving rates, population growth rates and production function

Question 18

What is the club convergence theory?

Answer 18

States that countries may be part of a ‘club’ (countries with similar saving rates, financial markets, propert rights, heath etc..)

Poorer countries that are part of this club will grow rapidly to catch up to their richer peers.

Question 19

What are the likely benefits that countries will receive when removing trade barriers ?

Answer 19

1. Increased investment from foreign savings
2. Allows focus on industries where the country has a comparative advantage
3. Increased markets for domestic products, resulting in economies of scale
4. Increased sharing of technology and higher total factor productivity growth
5. Increased competition leading to failure of inefficient firms and reallocation of their assets to more efficient uses

Question 20

What are the two equations using the “Growth Accounting Relation” to calculate the growth rate of potential GDP?

Answer 20

1. = Long term growth rate in technology + a(long term growth rate in capital) + (1-a)(long term growth rate in labor)
2. = long term growth rate in labor force * long term growth rate in labor productivity

Question 21

Under the neoclassical theory, how do you calculate the sustainable growth of output per capita (g*)?

Answer 21

Question 22

What are the 3 factors that determine the growth in aggregate stock market valuation?

Answer 22

1. GDP Growth
2. Growth in earnings relative to GDP
3. Growth in the price to earnings ratio

Question 23

What is the formula to calculate the growth in aggregate stock market valuation?

Answer 23

∆P = ∆GDP+∆(E/GDP)+∆(P/E)

Question 24

What does the alpha code represent in the Cobb-Douglas function?

Answer 24

it equals the share of output allocated to it

**they are % that must add up to 100%**

**in the equation they are decimals not %s**