SEMESTER 1 - SEMINAR 1 - PRODUCTION AND SOLOW MODEL Flashcards
The model has the following assumptions.
Single, closed economy where there is only one consumption good.
There is a certain number of people available to produce the consumption good. This number is denoted by L ̄ (labour).
There is a certain number of machines to produce the consumption good. This number is denoted by K ̄ (capital).
The economy is perfectly competitive: a large number of identical firms take prices as given and then decide how much labour and capital to use. Firms decide how many workers to hire and how many machines to rent in order to maximise profits.
They engage in production, pay their workers, and sell the good to the consumers.
1c) What is the solution for the equilibrium level of output per person?
2A
2
b) In column (5), use the production model (with a capital exponent of
1/3) to compute predicted per capita GDP for each country relative to the US, assuming that there are no TFP differences.
2d) Comment the general results that you find.
With no difference in productivity, the model predicts smaller
differences in income across countries than we observe. For many countries there is a fairly large gap between actual per capita GDP and the model’s predictions. In fact, the model systematically predicts that countries should be richer than they are. Differences in capital per person translate in much smaller differences in predicted GDP because of diminishing returns to capital.
Rich countries tend to have high levels of TFP and poor countries tend to have low levels. Differences in TFP (“technology”, “ideas”, “residual”) have a larger role than differences in capital in explaining differences in income between countries.
q3a
3b
We can see that Mexico has the highest steady-state level of capital and output. The saving rate in Mexico is lower than that of the rest of the countries (except Hungary). However, we can see that Mexico’s TFP parameter is quite a bit larger than that of the other countries. Second, we can see that Mexico’s a, the share of capital in output, is larger than those of Hungary and China and has a relatively low depreciation rate. Therefore, in the Solow model, these combined effects lead to a larger steady-state level than for any of the other countries. On the contrary, China has the lowest steady-state level of capital and output. China has the lowest TFP of all countries and the lowest capital share.
q4..
Japan is one success story of economic growth. Although today it is an economic superpower, in 1945 the economy of this country was in shambles. World War II had destroyed much of its capital stock. In this nation, output per person in 1946 was about half of what it had been before the war. In the following decades, however, this country experienced some of the most rapid growth rates on record. Assuming that labour supply remained fixed, with the use of the Solow diagram discuss the impact of the war on economic growth on this country both during the war and when the war ended. Also draw a graph showing how output evolves over time.
If we begin by unrealistically assuming the labour supply remained fixed, the war’s destruction caused K ↓ toward the origin, and output decreased (note that the depreciation rate remained unchanged). Following the end of the war, as capital “re-accumulated”, the Japanese economy experienced relatively rapid growth, due to the shape of the production function. Eventually, the economy returned to its previous level of output. It is important to notice that since there has been no change in the investment rate, the productivity parameter, or the depreciation rate, there is no change in the steady-state level of capital. Therefore, the Japanese economy just returned where it began.
second figure shows the level of output over time assuming that the shock occurred in 1945. Output declines intermediately because of the fall in capital. The economy then starts growing to return to steady state. Over time the growth rate itself reduces as the economy approaches the steady state, following the principle of transition dynamics.
