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EC102: CLASS 1 LT Christina Ammon Overview Each class we cover the quiz and the essay Sometimes will not have enough time for both – priority given to essay Will collect all essays each week, but mark one or two each week Can give detailed feedback/ can come to office hours to discuss Today: a lot to do, focus mostly on Essay + Question 3 of Quiz Growth – Why do we care? One of the earliest big questions in economics: why are some countries richer than others? Singapore vs. Haiti: • Nominal: 55182 vs 820 => 67 x higher • PPP adjusted: 78763 vs. 1703 => 46 x higher What makes Singapore so much richer than Haiti? The Solow model In agricultural world: main input to production: land & labor If Land is good quality – higher income, if not - lower income No economic growth possible! Solow model: in industrial world main input capital and labor Now if people save: can build new capital => capital can be accumulated through savings i.e. what people save now, will be turned into capital next period => can let the economy grow BUT: in classic solow model only to a point. Why? Decreasing returns to capital At some point capital not productive enough anymore to cover depreciation Essay Question a Consider an economy with a government, consumers, and firms, but no foreign sector (no exports and no imports). Write down an expression for GDP in terms of expenditures. Accounting identity: Income=Expenditure=Production Can either express income in terms of production or expenditure Call Y whatever is being produced i.e. GDP => GDP in terms of expenditure is: Y=C+I+G Note: in terms of production express income as: Y=F(K,L) Essay Question b Use the expression in (a) to derive an expression for investment. Can simply rearrange I=Y-C-G Essay Question c Suppose that consumption is a fraction (1-s) of GDP while the government spends a fraction t of GDP on government purchases. Rewrite the expression for investment in terms of s and t. Have from before: I= Y-C-G Now replace C=(1-s)Y G=tY I=(s-t)Y Essay Question d Assume s>t and no population growth. What is the law of motion of capital per worker? What is a law of motion? What determines how capital evolves? • New investments increase capital • Depreciation decreases capital ∆K=investment-depreciation Essay Question d Here have no population growth, so not necessary BUT: in general, turn in per capita terms (small letters) Divide Y=F(K,L) by L: Y/L=F(K/L, 1) => y=f(k) Investment per capita=I/l=(s-t)Y/L=(s-t)*f(k) Depreciation=δk ∆k=s*f(k)-δk Question 2 In the Solow growth model, increases in capital ______ output and ______ the amount of output used to replace depreciating capital. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; decrease Essay Question e Draw a diagram that illustrates the law of motion in (d) and use the diagram to describe briefly the growth process. How do we find the steady state? To solve Solow model – need to find the steady state Analogue to our idea of Equilibrium: “the situation in which nothing changes” => variable of interest (capital per capita) does not change i.e. ∆k=0 ∆k =(s-t)f(k*)-δk*=0 k*=(s-t)f(k*)/δ Essay Question f Suppose that the economy is in steady state, and the government reduces t to t’<t, what happens to the growth rate in the sort-run and in the long-run? Short run growth: • Look at if steady state changes • See if we are currently below or above steady state • • What happens to k*=(s-t)f(k*)/δ if t is reduced? Is our current k below or above the new k*? Long run growth? Essay Question g Explain the economic intuition for the result in (f). Essay Question h Consider two economies outside the steady state. The two economies have the same capital per worker, which is less than either country’s steady state. Country 1 has a higher t: t1>t2. Which economy do you expect to see growing faster? If t1>t2 => who has the higher steady state? k*=(s-t)f(k*)/δ Who is further away from their steady state? Do we grow faster closer to or further away from the steady state? What about long run growth? Question 3 Suppose that the labour force grows at rate n. The low of motion for capital per worker is: • ∆K = (s+n)Y –dK • ∆K = (s)Y –dK/n • ∆K = sY –(d+n)K • ∆K = sY –dK Question 3 ∆K =K’-K= sY –dK By definition k=K/L where L is total population. Also, K’/L’=k’ L grows at rate n. L’=L(1+n) K’/L’-K/L’= K’/L’ – K/L(1+n) = sf(K)/L(1+n) – dK/L(1+n) (1+n)k’-k=sf(k)-dk Rearranging: ∆k=sf(k)-dk-nk Question 3 Economic intuition Important: not important what is the size of population, but what matters is the growth rate i.e. that in the next period there are more people than in the previous one i.e. there are less people in one period saving, than there are people using the capital in the next period E.g. period 1: have 2 people saving a constant fraction of their income, let’s say 10 pound each If population growth is zero: next period have each 10 pounds worth of new capital (minus depreciation) If population doubles: each only have 5 pounds worth of new capital Question 4 Assume that a war reduces a country's labor force but does not directly affect its capital stock. Then the immediate impact will be that: A. total output will fall, but output per worker will rise. B. total output will rise, but output per worker will fall. C. both total output and output per worker will fall. D. both total output and output per worker will rise. Question 5 If two economies are identical (including having the same saving rates, population growth rates, and efficiency of labor), but one economy has a smaller capital stock, then the steady-state level of income per worker in the economy with the smaller capital stock: A. will be at a lower level than in the steady state of the high capital economy. B. will be at a higher level than in the steady state of the high capital economy. C. will be at the same level as in the steady state of the high capital economy. D. will be proportional to the ratio of the capital stocks in the two economies. Question 1 There is a positive correlation between • GDP and health • GDP per capita and health • GDP and pollution • GDP per capita and pollution