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
