Macro 3203 Final Short Answer + T/F

1) Convergence refers to what phenomenon regarding growth theory?

Convergence refers to the phenomenon where the levels of output per capita for countries tend to move closer to one another over time. This implies that countries that start with relatively lower levels of output per worker catch up to other countries and, in some cases, actually pass other countries.

T/F: Mismeasurement explains a large part of the decline in technological progress.

F, mismeasurement can explain only a small part of the decrease in measured productivity growth.

27) Suppose policy makers pass a budget that results in an increase in the budget deficit. Also assume that this fiscal policy action results in a reduction in the saving rate. To what extent will this reduction in the saving rate cause permanent changes in the rate of growth of output per worker? Explain.

A budget that causes an increase in the budget deficit will cause a reduction in the saving rate. Reductions in the saving rate will only temporarily affect the growth rates of Y and Y/N. Once the new balanced growth equilibrium is achieved, the growth rates of Y and Y/N will return to their original levels.

6) Briefly explain what effect a reduction in the saving rate will have on growth.

A reduction in the saving rate will reduce investment, capital and output. During the adjustment process, the rate of growth of output will be negative. However, at some point, I, K and Y will no longer fall. So, the reduction in the saving rate will not have a permanent effect on the rate of growth of output.

3) Explain each of the following: (1) constant returns to scale; (2) decreasing returns to capital; and (3) decreasing returns to labor.

All three of these things refer to characteristics of the production function. CRS means that if all inputs change by the same proportion, the level of output will change by the same proportion. Decreasing returns to capital and labor indicates that increases in either resource will cause output to increase but at a decreasing rate.

9) Briefly explain what effect an increase in the saving rate will have on growth.

An increase in the saving rate will increase investment, capital and output. During the adjustment process, the rate of growth of output will be positive. However, at some point, I, K and Y will no longer increase. So, the increase in the saving rate will not have a permanent effect on the rate of growth of output.

26) Suppose there is an increase in the saving rate. Explain what effect this increase in the saving rate will have on the rate of growth of output per worker.

As described in answers for the previous chapter, an increase in the saving rate will only temporarily affect the growth rates of Y and Y/N. Once the new balanced growth equilibrium is achieved, the growth rates of Y and Y/N will return to their original levels.

T/F: In virtually all the countries of the world, output per person is converging to the level of output per person in the United States.

F, output per person is converging across some countries but most still lag far behind the U.S.

T/F: Evidence suggests that happiness in rich countries increases with output per person.

F, output/person increases happiness in poor countries, but rarely in already wealthy countries

T/F: The price of food is higher in poor countries than it is in rich countries.

F, prices of goods, including food, are typically lower in poor countries

T/F: It is clear that the rate of technological growth has declined in the last decade.

F, technological growth has greatly improved in the last decade

17) Between 1950 and 1973, France, Germany, and Japan all experienced growth rates that were at least two percentage points higher than those in the United States. Yet the most important technological advances of that period were made in the United States. How can this be?

Even though the United States was making the most important technical advances, the other countries were growing faster because they were importing technologies previously developed in the United States. In other words, they were reducing their technological gap with the United States.

T/F: Technology has not played an important part in Chinese economic growth.

F, Although China's growth has been dominated by an increase in the capital stock per worker, there is no reason to believe that China has not benefitted from the increase in technology around the world and contributed to the development of that technology.

T/F: Capital accumulation does not affect the level of output in the long run, only technological progress does.

F, Capital formation cannot sustain growth alone, but it does contribute to long-term growth.

T/F: Education increases human capital and thus output. It follows that governments should subsidize education.

F, Even if you accept the premise (that educational investment increases output, as would be implied by the Mankiw, Romer, Weil paper), it does not necessarily follow that countries should increase educational saving, since future increases in output will come at the expense of current consumption. Of course, there are other arguments for subsidizing education, particularly for low-income households

T/F: Technological progress leads to a steady increase in unemployment.

F, In the United States, real output per person has increased by a factor of 10 since 1890 and, far from declining, employment has increased by a factor of 6.5 (reflecting a parallel increase in the size of the US population). As we have seen, the unemployment rate is very low. Nor, looking across countries, is there any evidence of a systematic positive relation between the unemployment rate and the level of productivity.

T/F: Workers benefit equally from the process of creative destruction.

F, Technological progress is good for consumers, but it can be tough on the workers who lose their jobs. A study by Davis and von Wachter (See textbook page 270) A mass layoff causes enormous relative earnings declines whether it occurs in a recession or an expansion. A society largely benefits from technological change, but it causes a large costs for the workers who lose their jobs compare to workers who have not experienced layoffs

T/F: A higher investment rate can sustain higher growth of output forever.

F, The economy will eventually reach a steady state where output per worker does not increase.

T/F: A higher saving rate implies a higher level of capital per effective worker in the steady state and thus a higher rate of growth of output per effective worker.

F, The steady-state rate of growth of output per effective worker is zero. A higher saving rate leads to higher steady-state level of capital per effective worker, but has no effect on the steady-state rate of growth of output per effective worker.

T/F: In a steady state, output per effective worker grows at the rate of population growth.

F, in steady state, there is no growth of output per effective worker.

2) Discuss and explain what is meant by the "state of technology."

First, we can think of it as the list of blueprints defining both the range of products that can be produced in the economy as well as the techniques available to produce them. Second, we can think of it as the way the economy is organized—from the internal organization of firms to the system of laws and the quality of their enforcement, in other words, the political system, legal institutions, and the quality of government.

22) Explain the difference between fully funded social security system and pay-as-you-go social security system.

Fully funded social security system taxes workers, invests their contributions in financial assets, and pays back the principal plus the interest to the workers when they retire. Pay-as-you-go system taxes workers and redistributes the tax contribution as benefits to the current retirees. There are two major differences between the two systems. First, what retirees receive is different in each case. Second, the two systems have different macroeconomic implications. In both systems private saving goes down. But in the fully funded system, public saving goes up and it has no effect on total saving and no effect on capital accumulation. In the pay-as-you-go system, the decrease in private saving is not compensated by an increase in public saving. Total saving goes down, and so does capital accumulation.

30) Explain how technological change can cause changes in wage inequality.

If the technological progress favors skilled workers, the demand for skilled workers will rise and the demand for relatively unskilled workers will fall. This would cause the wage gap to increase.

14) Suppose depreciation per worker is less than saving per worker. Given this situation, explain what will happen to each of the following variables over time: capital per worker, output per worker, saving per worker, and consumption per worker.

If depreciation is less than saving, it is also less than investment. Alternatively, there is excess investment to offset the amount of capital that wears out. So, the capital stock will increase. This will cause an increase in K/N, Y/N, and S/N. As Y/N rises, so will C/N.

12) In the model where it is assumed that the state of technology does not change, what parameters and/or variables cause changes in steady state output per worker.

In general, output per worker will depend on the capital-labor ratio. The equilibrium capital-labor ratio will depend on the saving rate and on the rate of depreciation. Output will also depend on the amount of human capital per worker. So, changes in s, δ, and H will cause changes in output per worker.

21) Suppose policy makers wish to increase steady state consumption per worker. Explain what must happen to the saving rate to achieve this objective.

It depends! Whether the saving rate must increase, decrease, or remain constant depends on what the current saving rate is compared to the golden rule saving rate. If 𝑠<𝑠𝐺, the saving rate must increase to increase steady state consumption. If 𝑠>𝑠𝐺, the opposite must occur.

31) Explain some of the causes of increased wage inequality.

Possible causes: skill-biased technological progress and international trade.

8) Briefly explain the relationship between output per capita and happiness. Specifically, to what extent are these two variables related?

Research by Richard Layard indicates that the proportion of very happy people is higher among the rich than among the poor. At the country level, at low levels of output per capita, increases in output per capita do seem to cause increases in happiness. However, this relation is not as strong for those countries with higher levels of output per capita.

T/F: The aggregate production function is a relation between output on one hand and labor and capital on the other.

T

T/F: For about 1,000 years after the fall of the Roman Empire, there was essentially no growth in output per person in Europe because any increase in output led to a proportional increase in population.

T, If output had increased and the population had stayed the same, then there might've been an increase in output per capita, but because people would increase the population as soon as output increased, the output per capita would just remain constant.

T/F: If capital never depreciates, growth could go on forever.

T, In the model without depreciation, there is no steady state. A constant saving rate produces a positive but declining rate of growth. In the infinite-time limit, the growth rate equals zero. Output per worker rises forever without bound. In the model with depreciation, if the economy begins with a level of capital per worker below the steady-state level, a constant saving rate also produces a positive but declining rate of growth, with a limit of zero. In this case, however, output per worker approaches a fixed number, defined by the steady-state condition of the Solow model. Note that depreciation is not needed to define a steady state if the model includes labor force growth or technological progress.)

T/F: In the past four decades, the real wages of low-skill U.S. workers have declined relative to the real wages of high skilled workers.

T, as tech becomes more advanced and a more integral part of the economy, high skilled / educated workers are more useful to firms

T/F: Writing the production function in terms of capital and effective labor implies that as the level of technology increases by 10%, the number of workers required to achieve the same level of output decreases by 10%.

T, it could be shown by algebra

T/F: If the rate of technological progress increases, the investment rate (the ratio of investment to output) must increase to keep capital per effective worker constant.

T, see Handout 25

T/F: The saving rate is always equal to the investment rate.

T, true in a closed economy, and if saving includes public and private saving

18) Suppose there is an increase in the savings rate. Explain what effect this will have on output, output per worker, the rate of growth of output, and the rate of growth of output per worker.

The increase in s will cause an increase in S/N and I/N. At the initial K/N, depreciation is less than investment. Alternatively, there is excess investment to offset the amount of capital that wears out. So, the capital stock will increase. This will cause an increase in K/N, Y/N, and S/N. As Y/N rises, so will C/N.

13) Explain the relationship among output, saving, and investment.

The level of output (per worker) will depend on the capital-labor ratio. The amount of capital will depend on investment (and depreciation). Investment will, in turn, depend on the amount of saving. Changes in saving will cause changes in investment, capital, and, therefore, output.

4) Suppose the capital stock increases by 10% and the number of employed workers increases by 5%. Given this information, explain what will happen to output and to output per worker.

The level of output will obviously increase because the amount of inputs has increased. Given that the capital stock increases by an amount greater than the amount of workers, we know that the capital labor ratio has increased. This implies that output per worker has also increased.

24) Explain what factors determine the slope of the required investment line.

The slope of the required investment line will depend on: the rate of depreciation, population growth, and rate of technological progress.

15) For an economy in which there is no technological progress, explain what must occur for the steady state to occur. Also explain what this implies about the rate of growth of output, output per worker, and the capital stock.

The steady occurs when the economy is in equilibrium. Specifically, the steady state refers to the situation where K/N and Y/N are constant. K/N will not change when investment per worker equals depreciation per worker. Once the steady state is reached, these variables are constant and the growth rates will be zero.

5) First, what are the primary determinants of output per worker? And second, to what extent can each cause a permanent change in economic growth?

The two primary determinants of growth are capital accumulation and technological progress. Capital changes when there are changes in investment and, therefore, the saving rate. Because the saving rate cannot increase forever, capital accumulation cannot cause permanent changes in economic growth. Technological progress, on the other hand, can result in permanent changes in economic growth.

23) Explain what factors determine how much investment is required to maintain a given level of capital per effective worker.

There are three factors that will affect the amount of required investment: depreciation, population growth, and rate of technological progress.

T/F: The US government should give tax breaks for saving because the US capital stock is far below the golden-rule level.

U, The U.S. capital stock is likely below the golden rule, but that does not necessarily imply that there should be tax breaks for saving. Even if the tax breaks were effective in stimulating saving, the increase in future consumption would come at the cost of current consumption.)

T/F: The higher the saving rate, the higher consumption in steady state.

U, see the discussion of the golden-rule saving rate

T/F: We should transform Social Security from a pay-as-you-g system to a fully funded system. This would increase consumption both now and in the future.

U/F, it is likely that the U.S. rate is below the golden rule rate and that transforming Social Security to a pay-as-you-go system would ultimately increase the U.S. saving rate. These premises imply that such a transformation would increase U.S. consumption in the future, but not necessarily in the present.

29) Joseph Schumpeter argued that growth was a process of creative destruction. Explain what is meant by the phrase, "creative destruction."

When TP occurs and new goods are developed, old goods will disappear. In those industries that produced these "old" goods, employment will decrease. It is this process of technological progress causing the destruction of old jobs that is referred to as "creative destruction."

25) Assume the economy has achieved the balanced growth steady state. Explain what factors determine the rates of growth of each of the following variables when balanced growth is achieved: output per effective worker, capital per effective worker, output per worker, output, and consumption per worker.

When balanced growth is achieved, K/NA and Y/NA are constant so their rates of growth are 0. K and Y must, therefore, grow at the same rate as NA which equals the sum of population growth and rate of TP. The rate of growth of Y/N will equal the rate of growth of TP. C will grow at the same rate as Y.

11) Consider the production function, 𝑌=√𝐾√𝑁, write the production function as a relation between output per worker and capital per worker.

Y/N = √(K/N)

7) Is it possible for a country to experience a permanent increase in output per worker over time? If so, how can this occur?

Yes, it is possible for sustained growth to occur. For sustained growth to occur, technological progress must occur. Changes in the saving rate will not cause sustained changes in growth rates.

10) Consider the production function 𝑌=√𝐾√𝑁 a) Compute output when K = 81 and N = 100. b) Is this production function characterized by constant returns to scale? Explain.

a) Y = 90 b) If both K and N double, Y also doubles. Yes, this production function is characterized by constant returns to scale.