ECON 112: GDP, Savings, and Investment

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Questions and Answers

Explain how a government budget deficit can lead to an increased trade deficit in an economy with both government and international sectors.

A government budget deficit can increase interest rates, attracting foreign capital, which appreciates the domestic currency and increases the trade deficit.

Using the Solow model, explain how a permanent increase in the savings rate affects the steady-state level of capital per worker and output per worker. What are the transitional dynamics?

An increase in the savings rate leads to a higher steady-state level of capital and output per worker. During the transition, growth is higher than the new steady-state level, gradually declining towards it.

In the Neoclassical growth model with constant technology, can the growth rate of output per worker be permanently positive? Explain.

No, the growth rate of output per worker is not permanently positive in the Neoclassical model due to diminishing returns to capital. Sustained growth requires technological progress.

Discuss the Golden Rule level of capital accumulation. What happens if an economy's savings rate leads to a steady state with more capital than the Golden Rule level?

The Golden Rule maximizes consumption in the steady state. If an economy has more capital than the Golden Rule level, it is dynamically inefficient, and reducing savings increases consumption at all points in time. Signup and view all the answers

Explain the concept of convergence in the Solow model. What assumptions are necessary for convergence to occur, and what factors might prevent it?

Convergence implies that poorer countries will grow faster than richer countries and eventually catch up. Assumptions include similar technology and preferences. Differences in institutions or technology can prevent convergence. Signup and view all the answers

In the context of the Malthusian model, why is technological progress considered essential for sustained improvement in per capita income?

Technological progress is essential because, without it, any increase in income leads to population growth, which eventually drives per capita income back down to subsistence levels. Signup and view all the answers

Using the Keynesian Goods Market Model, explain how an increase in government spending affects equilibrium income and output. What is the role of the multiplier in this process?

An increase in government spending increases equilibrium income and output. The multiplier amplifies the effect because the initial spending creates additional rounds of spending throughout the economy. Signup and view all the answers

Derive an expression for the multiplier in the Keynesian Goods Market Model. How does the marginal propensity to consume affect the size of the multiplier?

If the marginal propensity to consume is represented by $c$, and there are no taxes nor imports, the multiplier is $\frac{1}{1-c}$. A higher marginal propensity to consume results in a larger multiplier. Signup and view all the answers

Explain the difference between the GDP deflator and the Consumer Price Index (CPI) as measures of inflation. What are the key distinctions in their construction and coverage?

The GDP deflator measures the average price of all goods and services produced domestically, while the CPI measures the average price of a basket of goods and services purchased by a typical household. The GDP deflator includes domestically produced goods, while the CPI includes imported goods. The basket of goods is fixed for CPI, but changes yearly for the GDP deflator. Signup and view all the answers

If an econometric test of a Real Business Cycle (RBC) model yields the equation $y_t = 0.02 + 0.68y_{t-1} - 0.06y_{t-2} + e_t$, where $y_t$ is the growth rate of GDP, what does this imply about the dynamics of the economy?

The equation suggests that the current growth rate depends positively on the previous period's growth rate and negatively on the growth rate from two periods ago. The economy exhibits persistence in growth, but with some dampening effect over time. Signup and view all the answers

Flashcards

What is GDP?

Total value of goods/services produced in an economy, reflecting economic activity.

What is Real GDP?

GDP adjusted for inflation to reflect the real value of goods and services.