Chapter 28 Econ

True or false: Capital alone cannot be the key to economic growth

TRUE

The fraction of capital that depreciates is written as...

The amount it has depreciated DIVIDED BY 100

When investment is less than depreciation...

The capital stock shrinks and output is smaller

The greater the capital stock...

The greater the depreciation

Marginal product of capital

The increase in output caused by the addition of one more unit of capital; Diminishes as more and more capital is added

Bad aspect of spillovers

The originator does not get all the benefits □ If the originator doesn't get enough of the benefits, ideas will be underprovided □ Therefore too few ideas are produced

Conditional convergence

The tendency for poorer countries to grow faster than richer countries and this for poor and rich countries to converge in income

Many say that if people save too much, the economy will be hurt. They often refer to the fact that consumer spending is 2/3 of GDP to make this point. This is sometimes called the "paradox of thrift." What about in the real world? According to the data in Figure 26.10, is there a paradox of thrift?

There is no paradox of thrift in the real world, either: High-savings countries tend to be richer.

Simplest form of the Solow Model predicts that in the long run...

There will be zero economic growth

Advantages of countries that are catching up:

To become rich, a poor country does not have to invent the ideas already developed in the rich countries Catch-up countries (like China) grow through capital accumulation and the adoption of simple ideas that improve productivity

Consumption and investment increase when...

We produce more output Better ideas also increase capital accumulation

Steady-state level of capital

When investment equals depreciation, every unit of investment is being used to replace depreciated capital The amount of new investment is zero

When does a country grow most rapidly?

When it is below its steady-state level

Production function

Y = A*sqrt(K)

How are ideas like flames?

You can spread the idea to another person without losing the idea yourself. Non-rivalrous

Characteristics of a patent

§ Delay imitation § A majority of patented innovations are imitated within five years § Increase the incentive to research and develop new products, but also increase monopoly power once the products are created § Monopoly power not only raises prices, it also means that innovations take longer to spread throughout the economy

Government's role in the production of new ideas

§ Patents reduce spillovers; can also slow down the spread of new ideas due to increase in price § The government could subsidize the production of new ideas § The argument for government subsidies is strongest when the spillovers are largest § Universities produce scientists (government-subsidized universities)

Market size and research development

§ Pharmaceutical companies concentrate on drugs for common diseases because larger markets mean more profit § Larger markets mean increased incentives to invest in R&D

Depreciation function

(Depreciation rate) * K

Investment function

(Investment rate) * Y

The Solow Model

Beings with a production function

What drives long-run economic growth?

Better ideas

What is more important for explaining the standard of living in the rich countries: capital or ideas?

Better ideas.

Diminishing rates:

Capital (K) should produce more output (Y) but at a diminishing rate

Capital Growth Formula?

Capital growth = Investment - Depreciation

How can bombing a country raise its growth rate?

Capital stock is destroyed in war Any new capital stock becomes highly productive

Which countries are likely to grow faster: countries doing "cutting-edge" growth or those doing "catch-up" growth?

Catch-up: it's often easier to just imitate those who are doing it right already

How is China growing at such an alarming rate?

China began with very little capital, so they marginal product of capital was very high Over time, it will decrease as their capital continues to grow

Compared with its fast growth today, is China's economy likely to grow more quickly or more slowly in the future?

China is likely to grow more slowly in the future: As capital accumulates, the return to capital diminishes. As China gets closer to the cutting edge, it will have to grow by inventing new ideas rather than imitating and improving on existing ideas.

Spillovers mean that the social benefit of research and development...

Exceeds the private benefit

What does the production function do?

Expresses the way in which more inputs will produce more outputs

True or false: A successful economy does not need to replenish its capital stock

FALSE

Y

GDP

Better ideas is a way to...

Get more output from the same input Y = A (ideas) * sqrt(K)

Investment is equal to...

How many units are invested DIVIDED BY the total number of units The remaining amount has been consumed

Good aspect of spillovers

Ideas are NON-RIVALROUS (they can be shared freely)

The Economics of Ideas

Ideas can be freely shared by an unlimited number of people and they do not depreciate with greater use

Why aren't there enough good ideas?

Ideas tend to spill over and benefit other firms and consumers

A

Ideas that increase productivity

Better ideas...

Increase output directly and increase capital accumulation indirectly

Economic growth occurs when...

Investment is greater than depreciation

A greater investment rate means...

More capital, which means more output An increase in the investment rate increases a country's steady-state level of GDP

What is the equation for keeping track of capital?

Next year's capital = This year's capital + Investment - Depreciation

Many say that if people save too much, the economy will be hurt. They often refer to the fact that consumer spending is 2/3 of GDP to make this point. This is sometimes called the "paradox of thrift." In the Solow model, is there a paradox of third? In other words, is a high savings rate good or bad for a country's long-run economic performance?

No, there is no paradox of thrift in the Solow model: A high savings rate will make countries richer in the long run

What is capital?

Output that is saved and invested, but depreciates over time

When will people work harder to invent new ideas: when they can sell them to a market of 10,000 people or when they can sell them to a market of 1 billion?

People would rather sell to a market of 1 billion people

The 3 factors of production:

Physical Capital (K) Human Capital (eL) Ideas that increase productivity (A) Y = F(A, K, eL)

K

Physical capital

Cutting-edge

Primarily about developing new ideas

Why can't capital be enough to drive economic growth?

At some point, the capital stock will reach a level such that every unit of investment is needed just to replace the capital that depreciates in that period

Many people say that "the rich grow richer and the poor grow poorer." Is this what Figure 26.11 says about the countries in that graph? Did the rich countries grow more quickly or more slowly than the poor countries?

Among those countries, the rich ones grew more slowly, the poor ones grew more quickly. Overall the rich are growing richer but the poorer are growing richer even faster.

Economics of Ideas 1-4

1. Ideas for increasing output are primarily researched, developed, and implemented by profit-seeking firms 2. Ideas can be freely shared, but spillovers mean that ideas are underprovided 3. Government has a role in improving the production of ideas 4. The larger the market, the greater the incentive to research and develop new ideas

When will people work harder to invent new ideas: when they can patent those ideas for 1 year or when they can patent them for 10 years?

10 years: the longer-lasting monopoly is worth more

The Future of Economic Growth Forumla

A (Ideas) = Population * Incentives * Ideas per house

What is a patent?

A government grant of temporary monopoly rights, typically 20 years from the date of filing