Economic growth 1

What are the two types of steady state and which kind is the Solow Model?

Stable steady state is when over time, the system converges to steady state. Unstable steady state, is when the system leaves steady state, it will never come back. The Solow Model is stable because it will always move towards k*.

What is break even investment when there is depreciation, population change, and technology involved?

(δ +n +g)k

What can the government due to increase saving?

-Reduce government deficit or increase budget surplus (public saving) -reduce taxes, replace federal tax with consumption tax, expand tax incentives for retirement accounts (private saving)

How can government increase human capital?

Government can increase government capital by promoting education (investing in human capital). Ex. Public schools and subsidized education. Higher education=higher income.

What is the relationship between saving and investment in a closed economy?

Saving is equal to investment. This can be denoted by I=sY.

What does the Solow Model say about population growth?

Solow Model predicts that countries with higher population rates will have lower levels of capital and income per worker in the long run.

How do you get to the golden rule of capital when capital is too high?

To increase consumption, there must be a decrease in saving. The consumption will be higher in all points in time.

How do you get to the golden rule of capital when capital is too low?

To increase consumption, there must be an increase in saving. Future generations enjoy higher consumption but current consumption drops.

What do k and y denote?

k=K/L=capital per worker y=Y/L=output per worker

What are the differences between the Solow Model and the Endogenous growth theory?

-The Solow model predicts that sustained growth in living standards is due to tech progress and the rate of tech progress is exogenous. -The Endogenous Growth Theory is a set of models in which the growth rate of productivity and living standards is endogenous. -MPK is diminishing in the Solow Model but constant in the EGT

What is the growth rate of: -k -y -c -K -Y -C

-k:0 -y:0 -c:0 -K:n -Y:n -C:n

What are the three main reasons why some countries are poorer?

-low saving, low physical capital -low human capital -low efficiency due to slow technological progress and ineffective organization

What is an extractive institution?

An extractive institution protects the interests of the elite against new entry from competitors. It benefits only the elite.

How does an increase in population affect the Solow Model?

An increase in n causes an increase in break-even investment which leads to a lower steady-state level of k.

What are the two opposing effects that happen with an increase in saving (s)?

An increase in s leads to higher k* and y* which leads to higher c*. It also reduces consumption's share of income, which lowers c*.

What is break even investment?

Break even investment is the amount of investment necessary to keep k in the steady state. The economy must make at least this amount of investment to make sure k does not decrease.

What is the consumption function?

C=(1-s)Y

What can make a worker more productive?

Capital (K) is the stock of equipment and structures used to produce g and s. It is what makes workers more productive.

What is the difference between capital and lowercase variables.

Capital letters represent the aggregate variable while lowercase letters represent per capital variables.

What is capital per worker and how does it influence overall productivity?

Capital per worker can be denoted by K/L. Productivity is higher when the average worker has more capital. An increase in K/L will increase Y/L.

What is creative destruction?

Creative destruction is when new technologies replace old ones. This only happens in inclusive economic institutions.

What three factors that contribute to tropical poverty?

Diseases -there are more dangerous diseases in tropical areas due to their warm weather (ex. malaria) -women cannot work in the workforce because they are constantly taking care of their many children Agricultural productivity -high temp makes agriculture harder since the nutrients in soil and organic matter is eaten away quickly

What does the production function look like with efficiency?

F(K,L x E)

What is the steady state with population?

sf(k)=(δ +n)k

What is human capital (H) and what is it's relation to productivity and output?

Human capital (H) is the knowledge and skills workers acquire through education, training, and experience. The average worker's human capital can be denoted by H/L. Productivity is higher when the average worker has more human capital, so an increase in H/L will also increase Y/L.

What's the rule to whether save more or save less to reach golden rule?

If (MPK − δ) > (n + g ), An economy is below the Golden Rule steady state and should increase s. If (MPK − δ) < (n + g ), An economy is above the Golden Rule steady state and should reduce s.

Does capital have diminishing marginal returns?

If capital is defined as just plants and equipment, then there is diminishing marginal returns. If capital includes knowledge (endogenous growth theory), then it constant returns to scale.

If efficiency increased by 10%, how would capital have to change to prevent it from decreasing?

If efficiency increased at 10%, capital would also have to increase at 10%.

What would happen to the steady state if saving rate increase?

If saving increases, so will investment. Thus, k will go towards a higher steady state.

What does the Solow Model say about balanced growth and does it reflect reality?

In the steady state, Y/L and K/L grow at the same rate (g), so K/Y is constant. The real wage grows at the same rate is Y/L while rental price is constant. Both represent reality.

What's an inclusive economic institution?

Inclusive economic institutions have property rights, contract enforcement, competitive markets, and freedom of citizens to choose.

What's an inclusive political institution?

Inclusive political institutions have a broad distribution of political power. There are also limits to the power, such as democratic elections and constitutions.

What factors cause the growth of income in the long run?

Income growth in the long run is driven purely by technology and efficiency.

What are the ultimate causes of some countries being poor and some being rich?

Institutions, culture, geography and climate.

How is K and L represented in the Solow Model?

K and L are not fixed. Investment causes K to grow while depreciation causes K to decrease. Population growth increases L.

What type of good is knowledge?

Knowledge is a public good that is nonrival and low excludability.

What does the Golden Rule look like with population growth?

MPK = δ + n

What is the golden rule with technological progress?

MPK = δ + n + g OR MPK − δ = n + g

What does the basic model of the endogenous growth theory look like?

Main equation: ΔK = sY − δK If sA > δ, then income will grow forever, and investment is the "engine of growth." Here, the permanent growth rate depends on s. In Solow model, it does not.

What kind of nations are successful and what kind fail?

Political and economic institutions that are "inclusive" and "pluralistic" are successful while "extractive" institutions fail.

Who is Robert Solow?

Robert Solow is known for the Solow Model, which explains why and how economies grow.

How does technology affect productivity and what does the government do to promote it?

Technology increases productivity so the government promotes it through patent laws, tax incentives for private sector, and grants for basic research in universities.

What is the Golden Rule level of capital and how do you find it?

The Golden Rule steady state level of capital is the steady state value of k that maximizes consumption. To find, take the derivative of c*=f(k*) − δk* and set equal to zero. This is also the MPK, or slope of the production function.

What does the Solow Model say about income disparities and growth rate disparities?

The Solow Model implies that higher saving will lead to higher investment, which will lead to higher incomes. The Solow Model says that the growth rate will eventually be 0 (steady state), as well as income and consumption.

What does the Solow Model say about efficiency?

The Solow Model predicts that as efficiency increases, labor effectiveness will keep increasing. In the long run, rich countries will grow at a constant rate.

What does the Solow Model say about convergence?

The Solow Model predicts that will all things equal, poor countries with lower Y/L and K/L will grow faster than rich countries. This means that they will eventually converge with the rich countries. However, in the real world, poor countries do not grow faster than rich ones because not all things are equal. The Solow Model actually predicts conditional convergence, which is when countries converge to their own steady states.

What does the Solow Model say about poor country's growth rates vs rich country's growth rates?

The Solow Model suggests that poor countries (with lower capital per worker) grow faster than rich countries. This means that poor countries can catch up to rich countries. The growth rates will be high initially, but it will slow down.

What is considered the "best" steady state?

The best steady state is where consumption is the highest. This can be denoted by c* = (1-s) f(k*)

What rate does the number of efficient workers grow at and how does this affect capital per worker? What would prevent this?

The number of effective workers grows at g which causes the capital per worker to decrease at g. Investment equal to gk would prevent this.

What is the rate of depreciation?

The rate of depreciation is the fraction of capital stock that wears out each period.

What is the saving rate?

The saving rate is the fraction of income that is saved. It can be denoted by s.

What is the steady state capital stock?

The steady state capital stock is where sf(k) = δk, so change in k=0.

Why is productivity so important?

When a nation's workers are productive, real GDP is large and incomes are high. When productivity grows rapidly, so do living standards.

How do property rights affect political stability?

When property rights aren't enforced properly, there is less investment since they do not trust the government. This leads to lower living standards.

What do the variables Y and L stand for?

Y is the real GDP or the quantity of output produced. L is the quantity of labor.

What is the product function in the Endogenous growth theory?

Y=AK -A is the amount of output for each unit of capital -A is exogenous and constant

What is the production function and what are we focusing on for the Solow Model?

Y=F(K,L) Since output=income, we focus on changes in income per person (y) to help us understand changes in k.

What rate does L grow at?

n

What is the change in capital equation for the endogenous growth theory?

ΔK = sY − δK

What is the change in capital equation when both population and technology is added?

Δk = sf(k) − (n + δ + g)k

What does the change in capital per worker look like after the addition of population?

Δk = sf(k) − (n + δ)k Capital decreases as population increases because it spreads the capital more thinly among the population.

What does the change in capital (k) look like in per capita terms?

Δk = sf(k) − δk Investment increases capital stock while depreciation reduces it.