Economics: The Solow Growth Model

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Questions and Answers

What happens to the growth rate of the economy in the long run according to the Solow model?

It fluctuates periodically.

It stabilizes at a zero rate. (correct)

It grows steadily at a fixed rate.

It increases indefinitely.

Why does the economy reach a steady state in the Solow model?

The labor force continuously grows.

Investment equals depreciation. (correct)

Capital accumulates without limits.

Investment exceeds depreciation.

What role does diminishing returns play in the Solow model?

It causes output to increase at an accelerated rate.

It leads to higher investment rates over time.

It has no significant impact on economic growth.

It slows down the capital accumulation process. (correct)

What can be inferred about countries with high investment rates in the Solow model?

They have higher capital-output ratios. Signup and view all the answers

What does the capital-output ratio represent in the context of the Solow model?

The amount of capital needed to generate one unit of output. Signup and view all the answers

What does the picture taken from the International Space Station illustrate about North and South Korea?

South Korea is brightly lit at night, while North Korea is dark. Signup and view all the answers

What does the term 'The Great Divergence' refer to?

The long-term economic differences between countries that emerged at various points in time. Signup and view all the answers

In the context provided, which factor is highlighted by comparing North and South Korea?

Government policies and their influence on economic outcomes. Signup and view all the answers

What was the minimum average income likely to prevail in any economy at any point in time, as mentioned?

$1 per day Signup and view all the answers

Which comparison is used to illustrate economic development variations in the content?

Observing East and West Germany after WWII. Signup and view all the answers

What was the ratio of the GDP per person in the richest country to the poorest around the year 1300?

5 to 1 Signup and view all the answers

Which historical analogy is provided to describe the income disparity in modern economies?

The contrasting economies of Hong Kong and southeastern China. Signup and view all the answers

What is considered capital in the production process?

Computers used in an office Signup and view all the answers

If a steel producer generates $10 million of value added, what total GDP is generated by the automobile producer if the truck sales total $100 million?

$90 million Signup and view all the answers

Why is the production of used goods not counted towards GDP?

Only new production counts toward GDP. Signup and view all the answers

What term is used to identify the GDP figure subtracting depreciation?

Net domestic product Signup and view all the answers

How does the value-added method impact GDP counting?

It avoids double counting by only measuring final goods. Signup and view all the answers

In the production approach, what is an intermediate input?

Steel used for manufacturing cars Signup and view all the answers

What amount would contribute to GDP when a construction company builds and sells a new house for $200,000?

$200,000 Signup and view all the answers

What is the value added by the automobile producer if they sell trucks for $100 million, considering the $10 million cost of steel?

$90 million Signup and view all the answers

What is the impact on GDP if a used car sold for $20,000 was purchased for $17,000?

Does not change Signup and view all the answers

What does the exponent 1/3 on capital (K) in the Cobb-Douglas production function represent?

The output's sensitivity to changes in capital Signup and view all the answers

In the production function Y = ĀK 1/3 L2/3, what does Ā represent?

A parameter of the production function Signup and view all the answers

What is the purpose of economic models as described in the content?

To help in understanding and predicting economic phenomena Signup and view all the answers

If K = 8 and L = 27 in the production function Y = ĀK 1/3 L2/3, what is the output in units when Ā = 2000?

36,000 ice cream units Signup and view all the answers

What is the relationship between output (Y) and labor (L) in the function Y = ĀK 1/3 L2/3?

Output increases at a decreasing rate relative to labor Signup and view all the answers

In a Cobb-Douglas production function, what is implied by the sum of the exponents in the function?

The degree of returns to scale Signup and view all the answers

Which case represents the growth rate of zt if z = xy?

The sum of the growth rates of x and y Signup and view all the answers

What does the expression z = (x/y)^2 signify about the relationship between x and y?

z is the square of the ratio of x to y Signup and view all the answers

Which production function combines capital and labor equally?

z = x^(1/2)y^(1/2) Signup and view all the answers

What is true about the economic models as described in the content?

They are mathematical representations verified by empirical evidence. Signup and view all the answers

What does GDP stand for in the context of national income accounting?

Gross Domestic Product Signup and view all the answers

Which equation represents the expenditure approach to GDP?

Y = C + I + G + NX Signup and view all the answers

How is real GDP different from nominal GDP?

Real GDP accounts for inflation, while nominal GDP does not. Signup and view all the answers

What is the primary focus of the production approach to GDP?

Counting the value of final production only. Signup and view all the answers

What does it mean if labor's share of GDP is said to be relatively stable at about two-thirds?

Approximately two-thirds of GDP arises from labor income. Signup and view all the answers

What is a potential issue when using current prices from a recent year to estimate GDP for past years?

It distorts the measurement of historical economic activity. Signup and view all the answers

What do the price indexes, such as Laspeyres and Paasche, assist with in the context of GDP?

Computing real GDP across different years. Signup and view all the answers

In the given equation nominal GDP = real GDP × price level, what does the price level indicate?

The average prices of goods at a certain time. Signup and view all the answers

Which approach to GDP focuses on the sum of value added at each stage of production?

Production approach Signup and view all the answers

Study Notes

Development Economics 1

Lecture 1 overviewed the facts of economic growth, including why the richest countries grow at 2% per year and why some countries are 50x richer than others.
Growth vs. Development: A distinction was made between economic growth, a quantitative measurement, and economic development, which has a broader scope.
A case was made for the transformative power of economic growth in the US over a century. The drastic changes in life expectancy and household goods were used as examples.
Lecture one also presented examples of countries with low living standards for thousands of years.
The lecture concluded with a plan for the class, and references.

Growth Pattern (US Example)

GDP per person in the U.S. has grown at a remarkably consistent average rate of around 2% per year for nearly 150 years.
GDP per capita started around $3,000 USD in 1870, increasing to over $50,000 USD in 2014.
The Great Depression caused a significant decline in income. GDP per capita fell by nearly 20% in four years, but quickly recovered.
Growth before the Great Depression was slightly slower. This pattern shows greater stability post-1950.

Growth Pattern (World Example)

Living standards were mostly static for thousands of years before 1820- a period largely defined by hunters and gatherers.
Living standards began to increase faster in the 1800s, showing the acceleration of economic growth.
Historical data shows that the ratio between richest and poorest countries was roughly 5 to 1 in 1300. This ratio dramatically increased after 1820.

Economic Development

The lecture questioned why some countries are richer than others.
The production function and input vs. productivity concepts were explored.
The importance of rules and institutions was highlighted using examples like the differing economic paths of North and South Korea.
The concept of "catch up" growth was introduced, illustrating the ways different countries grow relative to each other. Historical examples, like the differing growth of East and West Germany.

How Growth is Spreading Across Countries

Between 1870 and 1929, global growth averaged 1.76%. In contrast, between 1870 and 2007, the average was 2.23%.
The period from 1900 to 1950 averaged 2.06. In contrast from 1950 to 2007, the average was 2.16%.
Living standards have increased fairly dramatically over the last two centuries.
Between years 1 and 1820, living standards in the West doubled.
During the next 200 years, GDP per person increased more than twentyfold.
The period from 1600–1820 illustrates that living standards initially changed modestly over time.

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Description

Explore the key concepts of the Solow Growth Model in this quiz. Discover how the model explains long-run economic growth, steady-state conditions, and the effects of investment rates. Gain insights into economic disparities illustrated by the case of North and South Korea.