Week 1 - Growth Facts & Model Of Production

Question 1

Define GDP

Answer 1

GDP is the market value of final goods and services produced in an economy at a given time.

Question 2

Define Real GDP

Answer 2

Real GDP is when we fix prices at a given baseline year and then compare what has happened to quantities over time as this shows us the ‘real’ GDP when prices are fixed.

Question 3

Briefly explain growth over the very long run

Answer 3

• Up until about 1800, GDP only differed only by a factor of 2/3 between rich and poor countries
• In the mid-1800’s The Great Divergence occurred, and now in the present GDP differs by a 15+ fold between richer and poorer countries.

Question 4

Briefly state what happened to modern economic growth in the US

Answer 4

From 1870 - 2000, the US real capita per GDP rose by nearly fifteen-fold

Question 5

Briefly explain why GDP is useful

Answer 5

• GDP is useful as it’s very easy to compare between different countries because it has an objective and consistent definition, and has a natural metric (money).
• It measures countries’ productive capacity, a crucial factor for improvements in health and other welfare dimensions.
• Consumption is part of GDP as its a measure of income
• GDP is strongly positively correlated with several direct measures of well being.

Question 6

Briefly explain the limitations of GDP

Answer 6

• Things that are important for SoL are not captured by GDP
• GDP does not measure things such as climate change inequality and working hours therefore does not show us if the growth is sustainable.

Question 7

What is the link between GDP and other well being measurements such as HDI and the Self-declared life satisfaction?

Answer 7

Strongly positively correlated, although it’s not perfectly correlated there is a strong link between GDP and standards of living.

Question 8

What are the 3 assumptions of our production function?

Answer 8

1. Single, closed economy (no international trade)

2. One consumption good

3. Two inputs: Capital (K) and Labor (L)

Question 9

Describe the Cobb Douglas Production function

Answer 9

Question 10

What are the 3 properties of the Cobb Douglas production function?

Answer 10

1. F(K,L) is increasing in both outputs, this means as you add inputs capital, and labor the production function increases.
2. Decreasing marginal products - As you add more K,L the rate of the increase in production falls.
3. Constant returns to scale - If we increase the amount of K,L by a quantity X, then the output will increase proportionality by X assuming X is greater than 0.

Question 11

Show the derivation to output per person?

Answer 11

Under constant returns to scale if we divide output by the number of workers, we get Y/L = F(K/L,1) which we can then rewrite as y=f(k), where lowercase workers denote per worker quantities and Y=K/L and k=K/L

Question 12

What can output per person be written as in Cobb Dogulas be written as?

Answer 12

y=Ak^a

Question 13

Up to what point do firms demand inputs of capital and labor?

Answer 13

Firms demand two inputs up to the point where their marginal products are equal to their marginal costs for Capital this will be to when MPK (Marginal product of K)=r(Marginal cost of K which is the rent of the equipment), and for Labor when MPL=W(Wage rate)

Question 14

What does the supply of capital and demand of capital and labor curves look like?

Answer 14

• Supply of capital and labor curves are horizontal as they are fixed and exogenous
• The demand for capital and labor curves are downwards sloping as the lower the interest and wage rate the greater the demand for capital and labor.

Question 15

Define equilibrium and general equilibrium?

Answer 15

• Equilibrium - Value of all endogenous quantities and prices such that markets clear
• General Equilibrium - This is when we have more than one market which is related.

Question 16

What are the features of the equilibrium, and state the equations for each of them.

Answer 16

• The equilibrium wage is proportional to output per worker
• The equilibrium rental ratio is proportional to the output capital ratio.
• Firms employ all the supplied capital and labor in the economy.
• Firms make zero profits ( perfect competition)
• Total output int he economy: Y = wL* + rK*

Question 17

What is the idea of development accounting?

Answer 17

If we have y*=AbarKbar ^a, to what extent are differences in y* due to cross country differences in Kbar, assuming A and a are the same for all countries.

Question 18

What is calibration?

Answer 18

Calibration involves setting model parameters to match empirical facts i.e setting values of parameters in accordance with real-world facts.

Question 19

What does the model of development accounting show vs actual data show?

Answer 19

The model underestimates the difference in GDP per worker between the US and india, for example in the India the model predicts that the GDP per capita is 40% but in reality, it is 10% of the US GDP.

Question 20

What does the total factor production (TFP) tell us about why rich countries are rich?

Answer 20

Shows rich countries are rich because:

They have more capital per person.

They use labor and capital more efficiently

Question 21

What does adjusting for PPP allow?

Answer 21

This is adjusted to allow differences in relative prices of goods in different places.

Question 22

What is the link between national income and consumption?

Answer 22

Evidence that there is a strong positive relationship, it shows rich countries are consuming more than 30x more than poorer countries whilst adjusted for PPP.

Question 23

What is the link between national income and life expectancy?

Answer 23

Richer countries have a life expectancy of about 80, whilst poorer countries have a life expectancy of 40.

Question 24

Based on the graph, for which country does the GDP gap with the UK definitley overestimate the corresponding life satisfaction gap

Answer 24

A. Botswana

B. Costa Rica - ans is Costa Rica

C. Malawi

D. South Korea

Question 25

In the model of production, we saw last time an increase in the (exogenous) supply of capital causes:

A. An increase in the rental rate of capital only

B. A decrease in the rental rate of capital only

C. A decrease in the rental rate of capital and an increase in the wage rate.

D. A decrease in the rental rate of capital and an increase in the wage rate

E. Ambiguous changes in factor pricing (depending on parameter values)

Answer 25

• The marginal product of labor is increasing in the capital stock (and vice versa)
• When capital increases, the wage increases
• This happens also in models where the evolution of capital is endogenous
• An example of the importance of working in general equilibrium

Answer is B

Question 26

Reading Q: What is the effect on the cross country income gap if its not adjusted for PPP

Answer 26

The cross-country income gap is considerably larger when there is no PPP adjustment. For example, without the PPP adjustment, GDP per capita in India and China relative to the United States in 2000 would be lower by a factor of four or so.

Question 27

What has been a major cause of growth miracles?