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EC 309 Study Guide for Midterm 3

by: Julie Knight

EC 309 Study Guide for Midterm 3 EC 309

Marketplace > University of Alabama - Tuscaloosa > Economcs > EC 309 > EC 309 Study Guide for Midterm 3
Julie Knight
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About this Document

This study guide covers chapter 8 and 9.
Intermediate Macroeconomics
Hoda A El-Karasky
Study Guide
EC, EC309, Economics, Macroeconomics
50 ?




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This 7 page Study Guide was uploaded by Julie Knight on Wednesday May 4, 2016. The Study Guide belongs to EC 309 at University of Alabama - Tuscaloosa taught by Hoda A El-Karasky in Spring2015. Since its upload, it has received 66 views. For similar materials see Intermediate Macroeconomics in Economcs at University of Alabama - Tuscaloosa.

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Date Created: 05/04/16
EC 309 Hoda Karasky EC 309 Intermediate Macroeconomics Test 3 Study Guide Chapter 8: Economic Growth II: Technology, Empirics, and Policy  Technology progress in the Solow model o A new variable: E= labor efficiency o Technological progress is labor augmenting- it increases labor efficiency at the exogenous rate g:    o Production function   ( ,  )  where LxE= the number of effective workers  increases in labor efficiency have the same effect on output as increases in the labor force o y=Y/LE  output per effective worker o k=K/LE  capital per effective worker o Production function per effective worker  Y=f(k) o Saving and investment per effective worker  Sy= sf(k) o  Growth empirics: balanced growth o Balanced growth- many variables grow at the same rate  Solow model predicts Y/L and K/L grow at the same rate (g), so K/L should be constant  This is true in the real world  Solow model predicts real wage grows at same rate at Y/L, while real rental price is constant  This is also true in the real world  Growth empirics: convergence o Solow model predicts that, other things equal, “poor” countries should grow faster than “rich” countries Hoda Karasky o If true, then the income gap between rich and poor countries would shrink over time, causing living standards to “converge” o In real world, many poor countries do NOT grow faster than rich ones o “Other things aren’t equal”  in samples of countries with similar savings and population growth rates, income gaps shrink about 2% per year  in larger samples, after controlling for differences in saving, population growth, and human capital, incomes converge by about 2% per year o Conditional convergence- countries converge to their own steady states, which are determined by saving, population growth, and education  this prediction comes true in the real world  Growth empirics: factor accumulation vs. production efficiency o Differences in income per capita among countries can be due to differences in:  1. capital – physical or human – per worker  2. the efficiency of production (the height of the production function) o Studies:  Both factors are important.  The two factors are correlated: countries with higher physical or human capital per worker also tend to have higher production efficiency. o Possible explanations for the correlation between capital per worker and production efficiency:  Production efficiency encourages capital accumulation.  Capital accumulation has externalities that raise efficiency.  A third, unknown variable causes capital accumulation and efficiency to be higher in some countries than others  Growth empirics: production efficiency and free trade o To determine causation, Frankel and Romer exploit geographic differences among countries:  Some nations trade less because they are farther from other nations, or landlocked.  Such geographical differences are correlated with trade but not with other determinants of income.  Hence, they can be used to isolate the impact of trade on income. o Findings: increasing trade/GDP by 2% causes GDP per capita to rise 1%, other things equal.  Policy Issues: evaluating the rate of saving o Use the Golden Rule to determine whether the U.S. saving rate and capital stock are too high, too low, or about right.  If (MPK   ) > (n + g ), U.S. is below the Golden Rule steady state and should increase s.  If (MPK   ) < (n + g ), U.S. economy is above the Golden Rule steady state and should reduce s. Hoda Karasky o To estimate (MPK   ), use three facts about the U.S. economy:  1. k = 2.5 y The capital stock is about 2.5 times one year’s GDP.  2.  k = 0.1 y About 10% of GDP is used to replace depreciating capital.  3. MPK  k = 0.3 y Capital income is about 30% of GDP  Policy issues: how to increase the saving rate o Reduce the government budget deficit (or increase the budget surplus). o Increase incentives for private saving:  reduce capital gains tax, corporate income tax, estate tax as they discourage saving.  replace federal income tax with a consumption tax.  expand tax incentives for IRAs (individual retirement accounts) and other retirement savings accounts.  Policy issues: allocating the economy’s investments o In the Solow model, there’s one type of capital. o In the real world, there are many types, which we can divide into three categories:  private capital stock  public infrastructure  human capital: the knowledge and skills that workers acquire through education o Two viewpoints:  1. Equalize tax treatment of all types of capital in all industries, then let the market allocate investment to the type with the highest marginal product.  2. Industrial policy: Govt should actively encourage investment in capital of certain types or in certain industries, because they may have positive externalities that private investors don’t consider.  Possible problems with industrial policy o The govt may not have the ability to “pick winners” (choose industries with the highest return to capital or biggest externalities). o Politics (e.g., campaign contributions) rather than economics may influence which industries get preferential treatment.  Policy issues: establishing the right institutions o Creating the right institutions is important for ensuring that resources are allocated to their best use. Examples:  Legal institutions, to protect property rights.  Capital markets, to help financial capital flow to the best investment projects.  A corruption-free government, to promote competition, enforce contracts, etc.  Policy issues: encouraging tech. progress Hoda Karasky o Patent laws: encourage innovation by granting temporary monopolies to inventors of new products. o Tax incentives for R&D o Grants to fund basic research at universities o Industrial policy: encourages specific industries that are key for rapid tech. progress  Endogenous growth theory o Solow model:  sustained growth in living standards is due to tech progress.  the rate of tech progress is exogenous. o Endogenous growth theory:  a set of models in which the growth rate of productivity and living standards is endogenous.  A basic model o Production function: Y = A K where A is the amount of output for each unit of capital (A is exogenous & constant) o Key difference between this model & Solow: MPK is constant here, diminishes in Solow o Investment: s Y o Depreciation:  K o Equation of motion for total capital:  DK = s Y   K  A two sector model o Two sectors:  manufacturing firms produce goods.  research universities produce knowledge that increases labor efficiency in manufacturing. o u = fraction of labor in research (u is exogenous) o Mfg prod func: Y = F [K, (1-u )E L] o Res prod func: DE = g (u )E o Cap accumulation: DK = s Y   K o In the steady state, mfg output per worker and the standard of living grow at rate E/E = g (u ). o Key variables:  s: affects the level of income, but not its growth rate (same as in Solow model)  u: affects level and growth rate of income Chapter 9: Introduction to Economic Fluctuations  Okun’s law- the negative relationship between GDP and unemployment  Index of leading economic indicators o Published monthly by the Conference Board. Hoda Karasky o Aims to forecast changes in economic activity 6-9 months into the future. o Used in planning by businesses and govt, despite not being a perfect predictor.  Components of the LEI index o Average workweek in manufacturing o Initial weekly claims for unemployment insurance o New orders for consumer goods and materials o New orders, nondefense capital goods o Vendor performance o New building permits issued o Index of stock prices o M2 o Yield spread (10-year minus 3-month) on Treasuries o Index of consumer expectations  Long run Prices are flexible, respond to changes in supply or demand.  Short run Many prices are “sticky” at a predetermined level.  The model of aggregate demand and supply o The paradigm most mainstream economists and policymakers use to think about economic fluctuations and policies to stabilize the economy o Shows how the price level and aggregate output are determined o Shows how the economy’s behavior is different in the short run and long run o The aggregate demand curve shows the relationship between the price level and the quantity of output demanded. o For this chapter’s intro to the AD/AS model, we use a simple theory of aggregate demand based on the quantity theory of money. o Chapters 10-12 develop the theory of aggregate demand in more detail. o o Aggregate supply in the long run  Y= F(K,L)  where Y, K, and L are all fixed Hoda Karasky o  Aggregate supply in the short run o Many prices are sticky in the short run  All prices are stuck at a predetermined level in the short run  Firms are willing to sell as much at that price level as their customers are willing to buy o Therefore, the short run aggregate supply (SRAS) curve is horizontal o o  Supply shocks o A supply shock alters production costs, affects the prices that firms charge. (also called price shocks) o Examples of adverse supply shocks:  Bad weather reduces crop yields, pushing up food prices.  Workers unionize, negotiate wage increases.  New environmental regulations require firms to reduce emissions. Firms charge higher prices to help cover the costs of compliance. EC 309 Hoda Karasky o Favorable supply shocks lower costs and prices.


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