Mankiw, Chapters 7 & 8

Mankiw, Chapters 7 & 8 Study Questions

1. Consider two economies, economy A and economy B. Suppose that over long periods of time, the average rate of Real GDP growth is higher in economy A than in economy B. Briefly (one sentence for each explanation) describe two (2) possible explanations for the fact that average Real GDP growth is higher in economy A than in economy B.

2. Explain briefly (2 or 3 sentences) why you agree or disagree with the following quotation:

"If the people of Japan began to save a lower fraction of their incomes, this would reduce the rate of Real GDP growth in Japan."

3. Suppose that the actual level of capital per worker in an economy (k) is greater than the steady state equilibrium level (k*) -- that is, k > k*. As the same time suppose that the steady state equilibrium level of capital per worker is less than the golden rule level: k* < k*GOLD . a. In the absence of any government policy to change the savings rate, will the actual level of capital per worker (k) tend to rise or fall in coming years? Explain in 1 or 2 sentences. b. Explain what happens to the level of consumption per capita (c) as the economy moves to the steady-state equilibrium.

4. Consider two countries that are similar in all respects except one: Country A has a much higher rate of population growth than country B. Which country probably has the higher standard of living? Explain in 3 or 4 sentences, using a graph if you find it helpful to do so.

5. Consider two countries that are similar today in all respects except one: Country C has a much lower stock of capital per worker (k = K/L) than country D. Which country is likely to have the more rapid rate of growth in output in coming years? Explain in 3 or 4 sentences, using a graph if you find it helpful to do so.

6. In his 1994 television addresses, US presidential candidate Ross Perot emphasized repeatedly that rate of improvement in the standard of living in the US has slowed considerably since the mid-1970s. He argued that the way to restore rapid growth in the standard of living was to balance the government budget -- that is, to reduce the deficit to zero. Were his arguments correct? Answer in 3 or 4 sentences, using a graph if you find it helpful to do so.

7. After listening to Ross Perot's speech, an economist argues that a better way to increase the rate of economic growth is for the government to implement a very large increase in spending on basic research, even if doing so increases the federal budget deficit. Use the model developed in Chapter 4 to critically evaluate this argument. Is this policy better or worse than the Perot policy? Explain why. NOTE: You may need to make some assumptions to answer this question. If so, be explicit about what your assume.

8. Describe three (3) reasons why in any particular year one country could have a higher level of Real GDP per capita than another. Sample Answers

1. I’ll give three reasons. (i) Country A has a higher rate of population growth (n). (ii) Country A has a higher rate of technological progress (g). (iii) Country A starts with a much lower level of k relative to k* than Country B.

2. A lower savings rate reduces the steady state level of output per worker (y*). Real GDP growth would slow down, but only during the transition to the new steady state equilibrium. The statement is true temporarily but not permanently.

3. a. When k > k*, then investment is less than deprecation and k falls. b. It depends on whether k is greater than or less than k*GOLD . If k < k*GOLD , then as k falls it will move farther away from k*GOLD and consumption per capita will decrease. If k > k*GOLD , then as k falls toward k*GOLD consumption will rise. k will continue to fall, however, because k* < k*GOLD , and k will fall until k = k*. Thus consumption will rise on net if the increase when k falls toward k*GOLD is bigger than the decrease when k moves away from k*GOLD . Consumption falls on net if the increase when k falls toward k*GOLD is smaller than the decrease when k moves away from k*GOLD .

4. A higher rate of population growth (n) means a lower steady state equilibrium level of output per capita (y*). If output per capita measures standard of living and both countries are in steady state equilibrium, then country A will have the lower standard of living than country B. [QUESTION: What if “standard of living” is consumption per capita????]

5. In country C k is probably well below k* while in country D k is probably close to k*. Thus in country C k will rise toward k*, which means that Y will rise faster than the rate [n+g]. In country D, Y will rise at about the rate [n+g]. Thus country C will have the faster growth rate. Remember that the Solow model predicts that “poor countries should grow faster than rich countries.”

6. Reducing the budget deficit increases government savings [by reducing dissaving], which in turn increases the economy’s savings rate [s]. A rise in the savings rate increases the steady state equilibrium level of capital per effective worker [y*]. Y will grow at a faster rate, but only during the transition to the new equilibrium. Once in the new equilibrium, it will again growth at rate [n+g].

7. The Chapter 4 model, strictly interpreted, does not support this policy. A higher government deficit means a lower savings rate [s], which reduces y* permanently and temporarily reduces the growth rate of Y. From that perspective it is worse than the Perot policy. One might argue, as do proponents of this policy, that the right kinds of government “investment” in infrastructure and research could increase the economy’s rate of technological progress [g]. If this is the case, then the policy would be better than the Perot policy.

8. In steady state equilibrium, a country could have higher Real GDP per capita because of (i) a higher savings rate [s], (ii) a lower population growth rate [n], or (iii) a lower depreciation rate []. It is also possible that a rise in AD could have output temporarily above the long-run equilibrium value.