Chapter 12 review

24. __________institutions are likely to shift the aggregate production function __________ and increase real GDP, while __________ institutions are likely to shift the aggregate production function __________ and decrease real GDP. A. Efficient; upward; inefficient; downward B. Inefficient; downward; efficient; upward C. Inefficient; upward; efficient; downward D. Efficient; downward; inefficient; upward

A. Efficient; upward; inefficient; downward FEEDBACK: An efficient institution, such as private property rights and efficient taxes, causes an economy to be able to produce more goods and services given the same level of resources. Inefficient institutions have the opposite effect, as they decrease goods and services production at any given level of resources.

17. Which of the following is NOT true about technological change in the Solow model? A. Technological change is random. B. Technological change occurs exogenously. C. Technological change is driven by the incentives of the innovators. D. Technological change is not due to any inherent characteristics of the economy.

C. Technological change is driven by the incentives of the innovators. FEEDBACK: The Solow model fails to identify what causes technological advancement. It assumes that technological change is purely random or exogenous and not due to any inherent characteristics of the economy.

15. Which of the following fosters positive economic growth? A. government-controlled markets B. widespread corruption C. closed trade D. efficient taxes

D. efficient taxes FEEDBACK: Efficient taxes limit production and income but are an important source of revenue for governments. As long as taxes do not impede production and income too much, they can aid government stability and promote economic growth.

13. Which of the following claims was NOT proposed by the modern growth theory? A. Capital resources cannot grow indefinitely. B. Technological change is caused by factors inside the economy. C. Technological changes are entirely unpredictable events. D. Technological advances can shift the curve of the production function.

A. Capital resources cannot grow indefinitely. FEEDBACK: The new growth theory explained why technological advancement, the main driver of sustained growth, occurs in certain nations in contrast to others. The fundamental characteristic of modern growth theory is that technological change is endogenous, that is, caused by factors inside the economy. Thus, economic growth can be influenced by trying to create an environment that encourages technological change. This environment is shaped by institutions that frame the incentive structure within which individuals and businesses make decisions, institutions that include significant organizations, laws, and social mores. The result of technological advancement is an upward shift of the curve of the production function, as in the revised Solow model.

Which of the following is true for an economy before it reaches the steady state? A. Investment and net investment are both positive. B. Investment is positive but net investment is zero. C. Investment is zero but net investment is positive. D. Investment and net investment are both zero.

A. Investment and net investment are both positive. FEEDBACK: Once an economy reaches the steady state, investment still takes place just to offset depreciation. Thus, although there is investment at the steady state, net investment is zero and there is no addition to the capital stock. On the other hand, before an economy reaches the steady state, addition to capital stock is possible if net investment is positive. This implies that there is positive investment that outweighs depreciation before the economy reaches the steady state, thus increasing capital stock of the country.

22. Which of the following will result in a shift of the aggregate production function? A. a technological advance B. training of the workforce C. an increase in the country's capital stock D. a boost in available natural resources due to discovery or other acquisition

A. a technological advance FEEDBACK: We know from the second Solow model that a technological advance will shift the aggregate production function upward. An increase in the country's capital stock or training, or in natural resources, will result in an upward movement along the same production function to a higher level of output produced.

7. If building new capital is costless and the capital depreciation rate is zero, then an economy will reach a steady state in which the marginal product of capital is what? A. equal to zero B. greater than zero C. less than zero D. The answer will vary from one economy to the next.

A. equal to zero FEEDBACK: A country will invest in capital as long as the benefits from additional units of capital exceed the cost of building capital. If the cost of building new capital is zero, then the country should invest in capital until all benefits from incremental capital have been exhausted, which occurs when the marginal product equals zero. If a country has a positive depreciation rate, capital should be produced as long as benefits from additional capital also replace worn-out capital stock. So it is expected that with positive depreciation, a steady state will be achieved while the marginal product of capital is still positive. On the other hand, if a country experiences no depreciation of capital stock, a steady state will be achieved once additional benefits from incremental capital have been depleted--in other words, when the marginal product equals zero.

10. The idea of convergence suggests that when underdeveloped nations begin to develop, they typically have A. higher growth rates as they catch up to developed nations. B. lower growth rates as they catch up to developed nations. C. similar growth rates as they catch up to developed nations. D. very low growth rates as they catch up to developed nations.

A. higher growth rates as they catch up to developed nations. FEEDBACK: The underdeveloped nations can catch up quickly because the older, developed economies have already made new discoveries and documented the mistakes to avoid in the development process. The new developing nations can choose the best equipment, tools, and practices, and thus catch up faster to the developed nations.

21. Which of the following statements is supported by the modern growth theory? A. Population growth is an obstacle to economic growth. B. Competition encourages discovery of new goods and services, which leads to economic growth. C. A country can grow faster if it disengages itself from international trade with foreign nations. D. Taxes should be abolished, as they hurt incentives necessary for economic growth. E. Population growth is an obstacle to economic growth, and competition encourages discovery of new goods and services, which leads to economic growth

B. Competition encourages discovery of new goods and services, which leads to economic growth. FEEDBACK: According to modern growth theory, the key to economic growth is institutions that frame the incentive structure within which individuals and businesses make decisions, institutions that include significant organizations, laws, and social mores. Thus, competition, international trade, and tax structure fall under the list of institutions proposed by the new growth theory. Competition facilitates growth by reducing inefficiencies and encouraging innovation. International trade is also an integral part of economic growth, since specialization and trade allow all nations to gain through production of goods for which they enjoy a competitive advantage. Finally, a strong and consistent government is necessary to aid in economic growth, and taxes are the revenues required to support an effective government. So taxes should be efficient to assist economic growth, rather than abolished.

12. What is the primary difference between the basic Solow model and the second Solow model? A. The models are theoretically similar. The second Solow model is only more mathematically complex than the basic model. B. The second Solow model allows for technological change, while the basic model doesn't. C. The basic Solow model features diminishing returns, in contrast to the second model. D. The marginal product eventually becomes zero in the basic model, while such a situation is avoidable in the second Solow model.

B. The second Solow model allows for technological change, while the basic model doesn't. FEEDBACK: The first Solow model stresses the importance of capital resources as a source of economic growth, while the second model allows for the possibility of technological advance resulting in sustained economic growth. Allowing for technological advance, the economy's aggregate production function shifts upward, and the production function becomes steeper at all points. But the behavior of the marginal product along the production function remains the same as in the basic Solow model.

6. All of the following can result in economic growth except A. improved schools and colleges. B. a boost in population growth. C. a favorable climate. D. an improved health care system.

B. a boost in population growth. FEEDBACK: Improved schools and colleges will result in an increase in human capital. A favorable climate means an increase in natural resources. An improved health care system can increase productivity in the same way physical capital does. All of these factors will result in more output per worker and hence economic growth. On the other hand, if the population of a country increases, and if total output does not increase proportionally, per capita GDP will decrease.

5. After the Great Depression, the main focus of macroeconomics was A. growth theory. B. the study of business cycles. C. the study of stock markets. D. the study of why businesses fail.

B. the study of business cycles. FEEDBACK: In 1776, Adam Smith's renowned book An Inquiry into the Nature and Causes of the Wealth of Nations spurred the early interest in the theory of economic growth. After the Great Depression of the 1930s, macroeconomics shifted to the study of business cycles, until the 1950s, when the primary focus of macroeconomics returned to the study of long-run economic growth.

18. Which of the following is NOT true after allowing for sustained technological advance in the Solow Growth Model? A. The steady-state situation is avoidable. B. The marginal product of each unit of capital will increase as a result of the advance. C. A diminishing marginal product is avoidable. D. The marginal product of each unit will continue to be positive.

C. A diminishing marginal product is avoidable. FEEDBACK: Allowing for technological advance, the economy's aggregate production function will shift upward, and the production function will be steeper at all points. This implies that each unit of capital now adds more to output than in the past--in other words, the marginal product of each unit of capital will increase, and so obviously will continue to be positive. In addition, a higher marginal product implies that the economy can now produce further and grow before it reaches a new steady state. Thus, sustained technological advances can allow sustained economic growth, thereby avoiding a zero-growth, long-run equilibrium. However, the shape of the aggregate production function remains the same: as we move along the new production function, the positive slope decreases with each additional unit of capital along the same curve. Thus, diminishing marginal product property still holds with the shift of the production function.

11. What is the key difference between the modern growth theory and the growth theory as envisioned by Solow? A. There is no difference; technological change is endogenous in both these theories. B. There is no difference; technological change is exogenous in both these theories. C. Technological change is endogenous in the new growth theory and exogenous in the Solow theory. D. Technological change is exogenous in the new growth theory and endogenous in the Solow theory.

C. Technological change is endogenous in the new growth theory and exogenous in the Solow theory. FEEDBACK: The growth theory envisioned by Solow stressed the importance of capital resources and technological change as sources of rapid economic growth. But it was silent about why innovations occurred in wealthy nations and not in the poorer nations. Thus, technological change in the Solow model was regarded as an unpredictable, random event. The modern growth theory proposed that technical change is caused by factors inside the economy and hence is endogenous.

23. Which of the following would be considered physical capital? A. knowledge acquired in culinary school B. wheat used in bread production C. an oven used to bake bread D. a method that improves bread production

C. an oven used to bake bread FEEDBACK: Physical capital consists of buildings, tools, and equipment. Of the choices available, only an oven falls under this definition. The other choices are other types of resources or technology.

9. The Solow Growth Model serves as a foundation of A. macroeconomic theory. B. microeconomic theory. C. growth theory. D. all economic theory.

C. growth theory. FEEDBACK: Growth theory began with the Solow Growth Model, which was developed in the 1950s and still serves as the foundation for growth theory, in both method and policy.

8. If the United States __________ business taxes to foster growth, this would be included in an __________ growth model, as opposed to an __________ growth model. A. raised; exogenous; endogenous B. raised; endogenous; exogenous C. lowered; endogenous; exogenous D. lowered; exogenous; endogenous

C. lowered; endogenous; exogenous FEEDBACK: Institutions are a part of endogenous growth theory. Efficient taxes are one such institution. When the United States lowers business taxes to foster growth, as it sometimes does, it is using an endogenous growth model.

4. According to the Solow Growth Model, which of the following is/are the primary source(s) of economic growth? A. natural resources B. human capital C. physical capital D. natural resources and human capital E. natural resources and physical capital

C. physical capital FEEDBACK: Early growth theorists observed that capital resources in wealthy nations far exceeded those available in developing nations. Additionally, periods of investment growth in developed economies were found to be positively correlated with real GDP growth. Also, it is quite natural that workers are more productive when they have more tools. Thus, the basic premise of the first Solow Growth Model was that physical capital is the primary source of economic growth.

14. Which of the following combination of institutions would lead to positive economic growth? A. political instability, inefficient taxes, and closed trade B. private property rights, efficient taxes, and closed trade C. private property rights, efficient taxes, and open trade D. public ownership of all property, efficient taxes, and open trade

C. private property rights, efficient taxes, and open trade FEEDBACK: Private property rights, efficient taxes, and open trade are three types of efficient institutions that promote growth by providing incentives to invest and allowing specialization in production.

19. Which of the following is false? A. Real-world observations shape economic theory. B. Economic theory shapes policy decisions C. Policies affect real-world events. D. Economic theory has no impact on real-world events.

D. Economic theory has no impact on real-world events. FEEDBACK: Economic theory shapes policy decisions that are designed to pursue certain economic goals. Once these policies are implemented, they affect the daily lives and well-being of people all around the globe. Thus, economic theory has an impact on real-world events.

16. Which of the following is NOT a barrier to natural growth? A. corruption B. political instability C. high tax rates D. free markets

D. free markets FEEDBACK: Corruption, political instability, and high tax rates are all barriers to natural growth. In comparison, free markets facilitate growth by reducing inefficiencies and encouraging innovation.

2. According to modern growth theory, the low living standards in many developing countries can be explained by a lack of A. natural resources B. free markets. C. sound institutions. D. free markets and sound institutions.

D. free markets and sound institutions. FEEDBACK: According to modern growth theory, the key to economic growth is institutions that frame the incentive structure within which individuals and businesses make decisions, institutions that include significant organizations, laws, and social mores.

3. According to the Solow Growth Model, the marginal product of capital is A. zero and increases as the quantity of capital increases. B. zero and decreases as the quantity of capital increases C. negative and increases as the quantity of capital increases. D. negative and decreases as the quantity of capital increases. E. positive and decreases as the quantity of capital increases.

E. positive and decreases as the quantity of capital increases. FEEDBACK: The basic premise of the Solow Growth Model is that higher levels of capital lead to more output per worker. This means that the marginal product of capital is positive. At the same time, increasing the level of capital diminishes the additional gains that are available from the incremental units of capital. Hence, the marginal product of capital declines as the quantity of capital increases.

1. According to economists today, economic growth depends on A. resources. B. technology. C. institutions D. .resources and technology. E. resources, technology, and institutions.

E. resources, technology, and institutions. FEEDBACK: The theory of economic growth has evolved over the years, starting with the contributions of the economist Robert Solow about 60 years ago. Today, economists have reached a consensus that economic growth is determined by a combination of resources, technology, and institutions.