Understanding Economic Growth

Question 1

Understanding Long-Term Growth

Answer 1

Increases in economy’s potential output
• Economists typically focus on supply-side
• Rightward movements in AS curve over time
• But, some argue that AD has a role too
• Capital expenditure (I) is a component of AD
• Hysteresis
• Growth models focus on economy’s production function
• Relationship between inputs and real GDP
• Quantity and quality of factors of production

Question 2

Economy’s (aggregate) Production Function:

Answer 2

Output per worker (Real GDP/worker= Y/N=y)
• Capital per worker (K/N = k)
• Shape?
• Variables that shift curves?

Question 3

Economy’s (aggregate) Production Function:

Key assumptions:

Answer 3

• Substitutability
  
  • Constant Returns to Scale
  • Savings=Investment (S+T=I+G)
  • Diminishing Marginal Returns to Capital
  • And, technological change happens exogenously i.e. ‘serendipity’

Question 4

Understanding Long-Term Growth

• Key elements:

Answer 4

• Actual Investment as a proportion of Y and therefore, also as /N (per worker)
  
  • Required Investment covers for capital depreciation and growth in labour force (population)
  • Savings=Investment
  • Population
  • Technology (Innovation)
• Movement towards a ‘Steady State’.

Question 5

Short-term increase in level of technology (A):

Answer 5

Increased productive/technical efficency 
	• Increased y (for a given k)
	• Generates more savings (at given s)
	• Increases I (Actual Investment)(S=I) 
	• Surplus I (Actual > Required)
	• Increase in k
	• Reaches new equilibrium Steady State.