Macroeconomics and Economic Growth: Key Concepts and Models

What does the long run focus on in macroeconomics?

The determinants of economic growth.

What does the short run focus on in macroeconomics?

Economic fluctuations, recessions, booms, unemployment, and short-run inflation-output movements.

Is an economic model an exact replica of the economy?

No.

What is an economic model?

A simplified representation used to understand economic relationships.

If income grows at 5% per year, about how long does it take to double?

14 years.

What rule do you use to estimate doubling time?

The Rule of 70.

What is the Rule of 70 formula?

Doubling time = 70 / growth rate.

Where did modern economic growth begin?

The United Kingdom.

When did modern economic growth begin?

Around the mid-eighteenth century.

What does economic growth mainly study?

Long-term changes in per capita GDP.

Since approximately 1980, which country has been one of the fastest-growing economies?

China.

What is convergence?

When poorer economies catch up to richer economies by growing faster.

What is divergence?

When income gaps between economies grow larger.

Which listed country had per capita GDP higher than the United States in the exam material?

Singapore.

Do countries with larger populations automatically have higher per capita income?

No.

Across U.S. states, did richer states tend to grow faster than poorer states?

No.

What does catch-up growth usually suggest?

Convergence.

What is per capita GDP?

GDP per person.

Why is per capita GDP important?

It measures average income or living standards better than total GDP.

What does 'modern economic growth' mean?

Sustained long-term growth in income per person.

What does a production function show?

How inputs are turned into output.

What are the main inputs in the production model?

Capital, labor, and productivity.

What does Y represent in a production function?

Output.

What does K represent in a production function?

Capital.

What does L represent in a production function?

Labor.

What does A represent in a production function?

Total factor productivity or technology.

According to the production model, what is the biggest reason some countries are richer than others?

Total factor productivity, A.

What is total factor productivity?

How efficiently an economy turns capital and labor into output.

What does Cobb-Douglas usually look like?

Y = A K^α L^(1-α).

What is the Cobb-Douglas function without A?

Y = K^α L^(1-α).

In Y = K^α L^(1-α), what does α represent?

Capital's share of output.

In Y = K^α L^(1-α), what does 1 - α represent?

Labor's share of output.

If α = 1/3, what is capital's share?

1/3.

If α = 1/3, what is labor's share?

2/3.

What happens to wages when capital increases in the production model?

Wages rise.

Why do wages rise when capital increases?

Workers become more productive.

What is constant returns to scale?

Doubling all inputs doubles output.

What is diminishing marginal product?

Each additional unit of an input adds less extra output than the previous unit.

What does MPK stand for?

Marginal product of capital.

What does MPL stand for?

Marginal product of labor.

What is the firm's profit formula?

Profit = revenue - costs.

When does a firm have the optimal amount of capital?

When MPK = r.

What is r in the MPK = r condition?

The rental rate of capital.

If MPK > r, should the firm hire more capital?

Yes.

If MPK < r, should the firm use less capital?

Yes.

Which is not usually a direct explanation of TFP differences: institutions, human capital, natural resources, or labor stock?

Labor stock.

What is human capital?

Worker skills, education, training, and knowledge.

What is physical capital?

Machines, buildings, tools, equipment, and infrastructure.

What does the Solow model study?

Capital accumulation, saving, depreciation, productivity, and long-run output.

What is the Solow resource constraint?

Y = C + I.

What does C represent?

Consumption.

What does I represent?

Investment.

What does investment do to capital?

It increases capital.

What does depreciation do to capital?

It decreases capital.

What is depreciation?

Capital wearing out.

If a country has twice as many machines, what happens to depreciation?

Twice as many machines wear out.

What is net investment?

Investment minus depreciation.

What is capital accumulation?

The change in the capital stock over time.

Is capital a stock or a flow?

Stock.

Is investment a stock or a flow?

Flow.

Is capital accumulation a stock or a flow?

Flow.

What is the steady state?

The point where capital accumulation equals zero.

What is ΔK at the steady state?

Zero.

At steady state, what relationship holds between investment and depreciation?

Investment equals depreciation.

What is transition dynamics?

The analysis of how an economy moves toward its steady state.

In the basic Solow model, is the saving rate endogenous or exogenous?

Exogenous.

If people consume a bigger fraction of income, what happens to saving?

Saving falls.

If saving falls in the Solow model, what happens to long-run capital?

It falls.

If saving falls in the Solow model, what happens to long-run GDP?

It falls.

If a war destroys capital but A stays the same, what happens to growth during rebuilding?

Growth can become faster.

Does faster rebuilding after capital destruction mean the war was good?

No.

Why can a poor country grow faster in the Solow model?

Capital is scarce, so the marginal product of capital is high.

What does a higher investment rate usually do to growth, holding other things constant?

It raises growth during the transition to a higher steady state.

If South Korea has a higher investment rate than the Philippines, what should happen ceteris paribus?

South Korea should grow faster.

What is inflation?

The percentage change in the price level.

What is the inflation formula?

Inflation = (P_{t+1} - P_t) / P_t.

What is the classical dichotomy?

The long-run separation of nominal and real variables.

What is a nominal variable?

A variable measured in money terms.

What is a real variable?

A variable measured in goods, services, or purchasing power.

In the long run, does money growth mainly affect real GDP or inflation?

Inflation.

What is the quantity theory equation?

MV = PY.

What should happen if South Korea has a higher investment rate than the Philippines, ceteris paribus?

South Korea should grow faster.

What does M represent in MV = PY?

Money supply.

What does V represent in MV = PY?

Velocity of money.

What does P represent in MV = PY?

Price level.

What does Y represent in MV = PY?

Real GDP.

What is the growth-rate version of the quantity theory?

Money growth + velocity growth = inflation + real GDP growth.

How do you solve for inflation using the quantity theory growth version?

Inflation = money growth + velocity growth - real GDP growth.

If money growth is 7.3%, velocity growth is -3.1%, and real GDP growth is 2.9%, what is inflation?

1.3% if using the direct growth equation.

In the course answer key example, what was fixed and what inflation was predicted?

Real GDP was fixed; inflation was predicted to be 6.1%.

In the quantity theory, is money supply usually exogenous?

Yes.

In the quantity theory, what variables are treated as exogenous in the long run?

Real GDP, velocity, and money supply.

What is the essence of the quantity theory of money?

In the long run, money supply is a key determinant of the price level.

If the money supply doubles, does real GDP double in the long run?

No.

If the money supply doubles in the long run, what mainly doubles?

The price level.

What is money neutrality?

Money affects nominal variables in the long run but not real variables.

Does money neutrality hold better in the long run or short run?

Long run.

Can money have real effects in the short run?

Yes.

What relationship does the data show between money growth and inflation?

Positive relationship.

What equation connects nominal interest, real interest, and inflation?

The Fisher equation.