ECON-E321 FINAL EXAM

Solow Model: Exogenous Growth has two markets in the current period

First market: current consumption goods are traded for current labor Second market: current consumption goods are traded for capital

If the firm hires more labor, everything else held constant, then

the marginal product of labor falls

The rate at which one good can be converted technologically into another is called

the marginal rate of transformation

The real wage denotes

the number of units of consumption goods that can be exchanged for one unit of labor time

Which of the following is not equal to the others in equilibrium?

the price of consumption

A relationship that shows the technological possibilities for an economy as a whole is

the production possibilities frontier

A key determination of investment is

the real interest rate

In the Richardian Equivalence, a change in current taxes has no effect on

the real interest rate or on the consumption of individual consumers

At the competitive equilibrium with a positive proportional labor income tax,

the real wage before tax is lower than the marginal product of labor

With a linear production function in labor only, which of the following must be true?

the real wage equals total factor productivity

Which of the following is wrong with respect to an increase in total factor productivity?

the real wage is down

There is evidence that the income per worker is converging in

the richest countries, but not the poorest countries

The property that macroeconomic variables fluctuate together in patterns that exhibit strong regularities is called

co-movement

What is the endowment point?

consumption bundle the consumer gets when he consumes disposable income in the current period and future period

In the one-period competitive model we have been studying

consumption is endogenous and total factor productivity is exogenous

The endowment point is the consumption bundle in which

consumption is equal to disposable income in each period

The Golden Rule Quantity of capital per worker maximizes the steady-state level of

consumption per worker

The Golden Rule of capital accumulation maximizes the steady-state level of

consumption per worker

What are Intertemporal Decisions?

consumption-savings decisions trade-off between current and future consumption key variable: real interest rare r

If the correlation between GDP and y is -0.75, we say y is

countercyclical

Changes in government spending are not likely causes of business cycles because government spending induces business cycles would counterfactually predict

countercyclical real wages and countercyclical consumption

The two primary explanations for the excess volatility of consumption are

credit market imperfections and changes in market prices.

In the Richardian Equivalence, an increase in government spending

crowds out private consumption expenditures

The condition 1+r describes the representative consumer's

current consumption savings decision

The condition, MRS l, C = w, describes the representative consumer's

current period work leisure decision

In more modern times as opposed to the times of Malthus, higher standards of living appear to

decrease death rates and also decrease birth rates

In the Malthusian model, state-mandated population control policies are likely to

decrease the equilibrium size of the population and increase the equilibrium level of consumption per worker

In the steady state of Solow's exogenous growth model, an increase in total factor productivity

increases output per worker and increases capital per worker

In the endogenous growth model, an increase in the efficiency of human capital accumulation

increases the growth rate of human capital and increases the growth rate of output

A static decision is one that

involves planning over one time period

Human Capital

is the accumulated stock of skills and eduction that a worker has at a point in time

What is the Solow Model: Endogenous Growth model?

it is a model of human capital accumulation to determine growth rate

What is the aggregate quantity of capital in steady-state?

k=k*N

In the Two-Period Model with inter temporal decisions the slope of the indifference curves?

-MRS

In a one-period economic model, the government budget constraint requires that government spending

= taxes

A key characteristic of the production function in the endogenous growth model presented in the text is that

there are constant returns to scale in human capital

A key characteristic of the production function in the endogenous model presented in the class is that

there are constant returns to scale in human capital

An increase in savings can be brought about

through government policy

The per-worker production function relates output per worker

to capital per worker

Real business cycle theory argues that the primary cause of business cycles is flu cations in

total factor productivity

Richardian Equivalence with a cut in current taxes for a borrower:

-Decrease in T now means increase in T in the future -this leaves BC unchanged E1 shifts to the right on the BC towards A -there is an increase in saving by the amount of the current tax -consumer has more disposable income in current period than in future period -saves in current period to pay future tax burden

Human capital accumulation

(1-u)Hs the number of current efficiency units of labor devoted to human capital accumulation

If we (wealth) represents a two-period consumer's lifetime wealth and r denotes the real rate of interest, the slope of the consumer's budget line is equal to

-(1+r)

In the Two-Period Model with inter temporal decisions there is an increase in the real interest rate

-bc pivots around the endowment point E -we1 moves left to we2 -BC becomes steeper due to an increase in relative price of current consumption -future consumption becomes cheaper relative to current consumption

Increase in the real interest rate for a lender

-first consumption point is to the left of E -bc pivots around the endowment points (E is in lower half) -we1 moves left to we2 -BC becomes less steep -draw a BC parallel to the first indifference curve for the substitution effect Substitution effect Income effect (go directly up to new BC) C ambiguous, C' increases

Increase in the real interest rate for a borrower

-first consumption point is to the right of E -bc pivots around the endowment points (E is in upper half) -we1 moves left to we2 (more than before) -BC becomes steeper -draw a BC parallel to the first indifference curve for the substitution effect Substitution effect C decreases, C' ambiguous Income effect (up and to o the right to reach BC) -borrowing is more expensive

In the Solow Model: Endogenous Growth, the production function

-has no physical capital -only efficiency units of labor Y=zuH

What happens when there is a temporary income increase in the Two-Period Model with inter temporal decisions?

-increase current income -bc shifts outward -pure income effect

What happens when there is a permanent income increase in the Two-Period Model with inter temporal decisions?

-increase in current income and future income -bc shifts outwards (more than the temporary income shift)

Hows does a cut in current taxes effect the credit market equilibrium?

-real interest rate unchanged -government debt increases from b1 to b2

Two-Period Model with intertemporal decisions

-savings only in the first period -starting the current period with no assets -one real interest rate -no credit market frictions -no production, no investment - lump sum tax -representative consumer receives exogenous income (no work leisure decision)

In the Solow Model: Exogenous Growth what happens to the steady state when there is an increase in savings rate s?

-shift curve upwards, no change in BC -k1 increases to k2 -output per worker is higher since y=zf(k) -no effect on the growth rates of aggregate variables: K, Y, I, C growth rate at n

What happens when there is an increase in current income for a lender?

-we1 and we2 BC's do not intersect at an edowment point (they are parallel) -lifetime wealth increases -slope of BC is unchanged because real interest rate does not change at all -current and future consumption increase

The Richardian Equivalence burden of debt is not shared equally when:

1) there are current distributional effects of changes in taxes 2) there are intergenerational distribution effects 3) taxes cause distortions 4) there are credit market imperfections

What does the Solow Exogenous growth model make predictions on?

1. sources of economic growth 2. what causes living standards to increase over time 3. what happens to the level and growth rate of aggregate income when savings rate or the population growth rate rises 4. observe what happens to relative living standards cross countries over time

Consumer BC in Solow Model: Endogenous Growth

C= wuHs Hs= units of human capital uHs= number of efficiency units of labor devoted to work u= fraction of time devoted to working w= wage

Solow Model: Endogenous Growth Equilibrium

Consumption C=zUH human capital growth (H'/H)-1 =b(1-u)H-1

Government BC in Richardian Equivalence

Current Period G=T+B B: number of gov. bonds Present Value G+ (G'/1+r)= T + (T'/1+r) purchases=taxes

In the Two-Period Model with inter temporal decisions what is the BC of the consumer?

Current period C+S=y-t s>0 means the consumer is a lender s: savings rate of the representative consumer not savings rate Future period c'=y'-t'(1+r)s consumer chooses c', c, and s Lifetime BC c+ (c'-y'+t')/(1+r)=y-t

In the one-period model, what do we assume about household preferences?

Households prefer more to less

In the Solow Model: Exogenous Growth what happens to the steady state when there is an increase in the labor force?

Increase in labor force effects the variable n: -capital per worker=k decreases -BC= (n+d) shifts to the left from n1 to n2 since n increases the slope is steeper -output per worker decreases since y=zf(k) -aggregate output will grow at a higher rate which means higher income per worker

The Malthusian model performs poorly in explaining economic growth after the

Industrial Revolution

Which of the following is best characterized as being nonrivalrous?

Knowledge

The Malthusian model emphasizes fixity in which of the following factors of production?

Land

Solow Model: Exogenous Growth what does consumers not value?

Leisure

A competitive equilibrium has all of the following EXCEPT:

MPL = slope of PPF

A Pareto optimum requires all of the following except

MPL = w

The slope of the output per worker function is equal to the

MPk

When the capital is accumulated in the steady state, the marginal product of capital is equal to

MPk = (n+d)

In the Two-Period Model with inter temporal decisions the consumer optimizes when

MRS=1+r

Lenders

MRS=a less steep than a borrower's indifference curve

Borrowers

MRS=b more steep than a borrower's indifference curve

The presence of a distorting tax on wage income can result in

MRSl,C < MPL

A competitive equilibrium has all of the following:

MRSl,C = MRTl,C MRTl,C = MPN (MPN is just MPL) MPL = w

Solow Model: Exogenous Growth Representative Consumer Variables

N= population in current period Current Consumption C= (1-S)Y S= aggregate savings s=aggregate savings rate S=sY

Which of the following statements best describes the characters of accumulating physical capital and human capital?

Physical capital accumulation is subject to decreasing marginal returns, but human capital accumulation is not.

The Solow model emphasizes the role of which of the following factors of production?

capital

What is convergence in the Solow Model: Endogenous Growth?

Rich and poor countries are identical in every aspect except for starting per worker capital and output values, they will converge in the long run to the same level of growth of per-capita income (poor will catch up to rich with regard to living standards)

The Solow model emphasizes the role of which of the following factors of productivity?

capital

What do we assume about households and firms?

They optimize

The idea that an improvement in technology causes an increase in population but cases no increase in the average standard of living is attributed to

Thomas Malthus

Which of the following is not a feature of the steady state in Solow's exogenous growth model?

Total savings is steady.

The two most important American business cycle events of the twentieth century were

World War II and the Great Depression

When does the credit market clear in Richardian Equivalence?

Y=C+G S^p=B

Solow Model: Exogenous Growth Production Function

Y=zF(k,N) Slope= MPK adding one unit of k increases Y MPK is diminishing with k making the per-worker production function concave

Solow Model: Exogenous Growth Representative Firm Variables

Y=zF(k,N) Y= current output z= curent total factor productivity k=current capital stock N= current labor input Y/N= output per worker K/N= capital per worker

The per worker production function relates output per worker to

capital per worker

An increase in the real interest rate is an example of

a substitution effect and an income effect whose sign depends on whether the consumer is initially a borrower or a lender

How does an increase in the proportional labor income tax modify the budget constraint?

a tilting down

A competitive equilibrium is a state of affairs in which

agents are price-takers, and market clears

In a general equilibrium model

all prices are endogenous

The production possibilities frontier represents

all technologically feasibly combinations of consumption and leisure

In the Solow Model: Endogenous Growth the representative consumer

allocates time between supplying labor to produce output and accumulating human capital (no leisure)

In the Solow Model: Exogenous Growth of the labor market is

always determined by the inelastic supple of labor, N

In the Solow Model: Exogenous Growth what is capital?

an asset, consumer save by accumulating it

We assume leisure is a normal good. This implies that

an increase in (lump sum) taxes decreases the demand for leisure

When the wage increases, the substitution effect in the household's choices leads to

an increase in consumption and a decrease in leisure

An increase in second-period income results in

an increase in first-period consumption, an increase in second-period consumption, and a decrease in saving.

An increase in first-period income results in

an increase in first-period consumption, an increase in second-period consumption, and an increase in saving.

If government spending is held constant and Ricardian equivalence holds,

an increase in government savings is always matched by an equal reduction in private savings.

We assume that leisure is a normal good. This implies that

an increase in lump sum tax decreases the demand for leisure

Future capital stock in Y=zF(k,N) in the Solow Model: Exogenous Growth model

assume that capital stock wears out through use each period K'= (1-d)K+I k'= future capital stock k=current capital stock I=investment d=depreciation rate

In the Endogenous growth model, which variables change growth rate?

b and u b:parameter u:hours worked

In the endogenous growth model presented in the text, suppose that u represents the fraction of time spent working (as opposed to accumulating human capital) and b represents the efficiency of human capital accumulation. The growth rate of consumption equals

b(1-u)-1

For the Solow model to accurately explain the observed divergence of growth experience around the world, it would require

barriers to the introduction of new technologies

Real GDP values current production at

base year prices

In the endogenous growth model presented in the text,

both consumption and human capital grow at the same rate

The property of diminishing marginal rate of substitution follows from the property that the indifference curves are

bowed in towards the origin

If interest rate increases, lifetime wealth (we)

decreases

An increase in government spending

decreases consumption, increases output

In the steady state of Solow's exogenous growth model, an increase in the growth rate of labor force

decreases output per worker and decreases capital per worker

In the steady state of Solow's exogenous growth model, an increase in the population growth rate

decreases output per worker and decreases capital per worker

In an economic model, an endogenous variable is

determined by the mode itself

In an economic model, an endogenous variable is

determined by the model itself

In an economic model, an exogenous variable is

determined outside the model

Which of the following is not a reason for differences in total factor productivity across countries?

differences in the size of population

A lump-sum tax is a tax that

does not depend on the actions of the economic agent being taxed

In the endogenous growth model presented in the text, suppose that u represents the fraction of time spent working (as opposed to accumulating human capital), b represents the efficiency of human capital accumulation, H represents the amount of human capital, and d represents the marginal product of efficiency units of labor. Consumption equals

duH

If the government replaces a lump sum tax with a proportional labor income tax,

employment and output decrease

Fiscal policy refers to a government's choices over its

expenditures, taxes, tranfers, and borrowing.

The time constraint for the consumer is

expressed as leisure time + time spent working = total time available

When consumption and leisure are both normal goods, after an increase in real dividend income minus taxation, the rational consumer

increases consumption and reduces labor supply

An increase in total factor productivity

increases consumption, increases output, and increase the real wage

In the steady state of Solow's exogenous growth model, an increase in the savings rate

increases output per worker and increases capital per worker

In an exogenous growth model, growth is caused by

forces that are not explained by the mode itself

In an exogenous growth model, growth is cause by

forces that are not explained by the model itself

The condition, MRS l' C' = w', describes the representative consumer's

future period work

For a lender, an increase in the real interest rate

has an uncertain effect on current consumption and increases future consumption

In the Richardian Equivalence, the timing of the tax burden

has no effect on consumption, welfare, or the market real interest rate

The utility function captures

how an individual consumer ranks consumption bundles

The Malthusian model has the property that

improvements in technology for producing goods leads to increased population growth

If interest rate decreases, lifetime wealth (we)

increases

Before the Industrial Revolution, standards of living differed

little over time and across countries

What immediate consequence does an increase in education time have in the endogenous growth model with human capital?

lower output

Leisure includes all of the following except

market work

When the tax rate increases, the tax revenue

may increase or decrease

Growth accounting

measures contributions to growth in aggregate output fem growth in capital stock, in employment and in total factor productivity

All of the following increase total factor productivity except

more capital

We assume that the representative consumer's preferences exhibit the properties that

more is preferred to less and that the consumer prefers diversity

In a one-period model, government is likely to run

neither a surplus nor a deficit

Total factor productivity can be influenced by

new inventions

A consumer is a borrow if

optimum current consumption is greater than current disposable income

A consumer is a lender if

optimum current consumption is less than current disposable income

Points on the production possibilities frontier have the property that they

show the maximum amount of leisure that can be consumed for the given amount of goods consumed

In the Golden Rule steady state, the marginal product of capital is equal to the

population growth rate plus the depreciation rate

In the Malthusian model, the population growth rate is

positively related to consumption per worker

For the economy as a whole, investment represents a tradeoff between

present and future consumption

Percentage deviations from trend in the Solow residual are

pro cyclical and have about equal magnitude as percentage deviations from trend in GDP

Which feature of the business cycle does the one-period model replicate with shocks to government expenditures?

procyclical employment

The Solow model suggest that, in the long run,

production technology must become more efficient

if public goods can be produces more efficiently, then

public goods increase, and private goods may increase or decrease

An increase in government spending

reduces consumption, increases hours worked, and reduces the real wage

Countries in which a relatively small fraction of output is channeled into investment tend to have a

relatively low standard of living

In the context of the Solow growth model, so-called growth miracles, such as Japan, South Korea, Singapore and Hong Kong are most easily explained by

removal of barriers to technology

Growth accounting, popularized by Robert Solow, attempts to attribute a change in aggregate output

separately between changes in total factor productivity and changes in the supplies of factors of production

A competitive equilibrium is Pareto optimal if there is no way to rearrange to to reallocate goods so that

someone can be made better off without making someone else worse off

An increase in the real interest rate is an example of a

substitution and an income effect whose sign depends on whether the consumer is initially a borrower or a lender

The assumption that the current-period labor supply is positively related to the current-period real wage is justified as long as the

substitution effect dominates the income effect in the short run

In Solow's model of economic growth, suppose that s represents the savings rate, z represents total factor productivity, k represents the level of capital per worker, and f (k) represents the per worker production function. Also suppose that n represents the population growth rate and d represents the depreciation rate of capital. The equilibrium level of capital per worker, k* , will satisfy the equation:

szf(k*)=(n+d)k*

The Laffer curve is a curve showing

tax revenue as a function of the tax rate

Improvements in a country's standard of living are brought about in the long run by

technological progress

The production possibilities frontier in the one-period model is a

technological relationship between consumption and leisure

In the Solow Model: Exogenous Growth in the the long run,

the aggregate quantity of capital in steady-state is k=k*N consumption grows at rate n C= (1-s)zf (k*)N

Features of the steady state in Solow's exogenous growth model

the capital/output ratio is steady, the capital grows continuously, the consumption per worker is steady.

Proportional income taxation is distorting because

the competitive equilibrium is not Pareto optimal

Suppose that two countries share identical levels of total factor productivity, identical labor force growth rates and identical savings rates. According to the Solow model

the country with the smaller initial level of output per worker will grow more rapidly than the country with the greater initial level of output per worker

In Solow's exogenous growth model, the principal obstacle to continuous growth in output per capita is due to

the declining marginal product of capital

The Solow residual attempts to measure the amount of output not explained by

the direct contribution of labor and capital

With an increase in total factor productivity in the Solow growth model,

the economy reaches a steady state with higher output

In the Solow Model: Endogenous Growth what is the growth rate of per capita income determined by?

the efficiency with which human capital is accumulated

The marginal rate of substitution of future leisure for future consumption must be equal to

the future real wage

The second fundamental theorem of welfare economics states that

under certain conditions, a Pareto optimum is a competitive equilibrium.

The first fundamental theorem of welfare economics states that

under certain conditions, a competitive equilibrium is Pareto optimal

Relative to the social optimum, monopoly power directly leads to

underproduction

An increase in total factor productivity shifts the PPF

upward, and also changes its slope

The concept of Pareto optimality is a

useful concept because it defines economic efficiency

The concept of Pareto optimality is a

useful concept because it guarantees economic efficiency

In the Solow Model: Endogenous Growth, when does the market clear?

w=z UHs=UHd=H

A government surplus is

when its income is higher than its spending

In the Richardian Equivalence, the government

wishes to purchase G consumption goods in the current period

A consumer may increase his or her saving by

working more hours and consuming fewer goods in the present period

In the Solow Model: Endogenous Growth

you cannot save

For the production function, Y = zK0.36N0.64, if measured output is ˆY, measured capital input is ˆK, and measured labor input is ˆN , then the Solow residual would be equal to

z= Y / (K^0.36*N^0.64)

Suppose z increases in the Endogenous growth model

z=w, so z increases and w increases. when w increases, Y (output) increases. if output increases then consumption increases growth rate does not change.

In the Solow Model: Endogenous Growth, the firms profits are

zuHd-wuHd