Week 3 - Growth & Ideas - Romer Model

Question 1

What does the Romer Model assume about technological change A?

Answer 1

The Romer model takes technological change as endogenous, whereas in previous models it was exogenous

Question 2

What does Romer show in his findings?

Answer 2

• Knowledge to create new ideas can drive LR growth, however the economic forces affect the willingness for firms to innovate

Question 3

What does Romer suggest about the factors of production?

Answer 3

• Romer suggests the factors of production can be either objects or ideas
• Objects are finite whereas ideas he says are non rivalrous which means someone can use the idea and it doesn’t effect someone else’s consumption.

Question 4

What does the non rivalrous idea imply and explain this

Answer 4

• The non rival nature implies increasing returns to scale
• For example with objects, doubling the amount of objects doubles the amount of production.
• However, doubling objects and doubling ideas will lead to a more than double increase in production as other people will use the idea

Question 5

Explain the non rivalrous idea in terms of creating a vaccine

Answer 5

• If 1 firm spends £2bn on researching a vaccine and then when it finds the idea produces a vaccine £10, its overall cost was £2bn and £10.
• Another firm producing a vaccine can now produce it at £10 as the ‘idea’ is already in place so with the same amount of money £2bn and £10 can produce millions of vaccines showing the increase returns to scale for the economy.

Question 6

What is the production function with ideas included?

Answer 6

• Yt = F(At, Kt, Lt) = At Kt^a Lt^1-a

Question 7

Why would R&D be a problem in a perfectly competitive market?

Answer 7

• In perfect competition Price = Marginal cost

- Firms generate no profit, so have no money to invest in R&D so R&D cannot occur

Question 8

State 3 ways in which the government can help solve the R&D problem in a perfectly competitive market

Answer 8

1. Patents
2. Copyrights
3. Trade secrets protected by non-disclousure agreements

Question 9

What is the set up of the Romer Model?

Answer 9

• Model does not include physical capital K

- Y = At Lyt

Question 10

Explain the set up of labor in the Romer model

Answer 10

• Labor is divided into Labor of the production of goods Lyt, or Labor for the production of new ideas (Lat)
• Fancy l is the share of the labor force employed in the production of new ideas
• Lat = Fancy L x L(Labor force)

Question 11

What is the change in the stock of ideas in period t+1 equal to and explain these

Answer 11

• Change in At+1 = ZAtLat
• Z = the productivity of producing the new ideas
• At = Existing stock of ideas, as stock of new knowledge depends on the current knowledge
• Lat = Size of the labor force dedicated to the production of new ideas

Question 12

When solving the Romer model what does output per worker equal to and what does this mean?

Answer 12

• yt = Yt/L = At(1- fancy l)
• This suggests that output per worker depends on the total stock of ideas and the share of labor force dedicated to the production of the good.
• In the solo model output per worker depends on capital per worker as capital is rivalrous

Question 13

When solving the Romer model what do we conclude about the growth rate of knowledge g?

Answer 13

• The growth rate of knowledge g is constant over time
• g = z x fancy L x L
• Growth rate g = productivity of finding new knowledge x labor involved in finding new knowledge x size of the labor force

Question 14

What does the stock of knowledge At depend on?

Answer 14

• At = Ao(1+g)^t

- The stock of knowledge depends on the initial knowledge x the growth rate of the knowledge

Question 15

What does the Romer model predict in terms of economic growth

Answer 15

• Predicts long run growth as there is no diminishing returns due to ideas being non rivalrous

Question 16

What is the effect on the Romer model of an increase in the population?

Answer 16

• g = z x fancy l x L
• An increase in the population leads to an increase in L which leads to an increase in the growth rate which immediately and permanently increases output per person as:
• yt = Ao (1.-fancy l)(1 + g)^t, an increase in g leads to an increase in yt

Question 17

What is the effect on the Romer model of an increase in Research employment?

Answer 17

• yt = (1-fancy l)(1+g)^t
• An increase in research employment increases fancy l therefore output per person falls.
• However although output per person initially falls in the long run it increases as there is no a higher growth rate as g=z fancy l L and an increase in fancy l increases the growth rate

Question 18

In summary what does increasing growth require according to Romer?

Answer 18

1. More resources allocated to the production of ideas
2. Higher productivity in the production of ideas (e.g incentives to researchers as highly educated people are associated with higher productivity in producing ideas)