EC 309 Study Guide for Midterm 3
EC 309 Study Guide for Midterm 3 EC 309
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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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