GDP - Growth (Solow)

What is the primary focus of macroeconomics?

It studies the aggregate behavior and performance of an entire economy, such as that of a country or region.

How does macroeconomics differ from microeconomics?

Microeconomics studies the behavior of individuals and firms, while macroeconomics looks at the economy as a whole, tracking totals, averages, and interactions across markets.

What are the four main objectives of the macroeconomics course at Erasmus School of Economics?

To learn terminology, analyze macroeconomic questions using models, interpret data, and understand current macroeconomic issues.

What is the definition of Gross Domestic Product (GDP)?

The total value of all final goods and services produced within a specific area during a specific period.

While GDP is not a direct measure of happiness, it is highly correlated with _.

well-being

What is the key distinction between long-run and short-run economic performance?

The long run (trend) concerns the behavior of the economy over decades, while the short run (business cycles) involves temporary fluctuations around that trend.

What term describes the temporary output fluctuations around the long-run economic trend?

Business cycles.

In a business cycle, what is the period from a peak to a trough called?

A recession.

In a business cycle, what is the period from a trough to a peak called?

A boom.

What is the formula for calculating the GDP growth rate in year t?

$gr.ratet = (Yt / Y{t-1}) - 1$, where $Yt$ is the GDP in year t.

What are the two main components of the Balance of Payments (BoP)?

The Current Account (CA) and the Financial and Capital Account.

The Current Account (CA) records exports and imports of goods and services, as well as international receipts or payments of _.

income

What is the Trade Balance (TB)?

It is the net trade of goods and services, calculated as Exports minus Imports (X - Z).

If a country's income (Y) is greater than its domestic absorption (C+I+G), what is the state of its Current Account (CA)?

The Current Account is in surplus, and the country is a net lender.

The _ records transactions in financial assets between residents and non-residents.

Financial Account (FA)

In principle, the Balance of Payments (BoP) should equal zero based on the double-entry system, expressed as BoP = _.

$CA - (FA + KA) = 0$

What are the three main reasons for economic growth suggested by the Solow model?

Capital accumulation, population growth, and technological progress.

What is the 'steady state' in the Solow model?

The long-run equilibrium of the model economy where each variable grows at a constant rate.

What is the general form of the aggregate production function in the Solow model?

$Y = F(K, L)$, where Y is output, K is capital, and L is labor.

What are the two key assumptions about the production function in the Solow model?

Constant returns to scale and diminishing marginal product for each factor.

What is the formula for the Cobb-Douglas production function?

$Y = K^\alpha L^{1-\alpha}$, where $0 < \alpha < 1$.

In the Cobb-Douglas function $Y = K^\alpha L^{1-\alpha}$, what does the property of constant returns to scale (CRS) mean?

Doubling all inputs (K and L) will exactly double the output (Y).

What does diminishing marginal productivity of capital mean?

Each additional unit of capital increases output, but by a progressively smaller amount, holding labor constant.

What is the intensive form of the production function?

$y = f(k)$, where y = Y/L (output per worker) and k = K/L (capital per worker).

In the Solow model, what is the equation for the change in capital per worker ($\Delta k$)?

$\Delta k = s f(k) - \delta k$, where s is the savings rate and $\delta$ is the depreciation rate.

What condition defines the steady state in the basic Solow model?

The change in capital per worker is zero ($\Delta k = 0$), which occurs when investment equals depreciation ($s f(k) = \delta k$).

In the Solow model without technological progress, what is the long-run growth rate of output per worker at the steady state?

Zero.

How does an increase in the saving rate (s) affect the economy in the Solow model?

It raises the steady-state level of output per worker but does not affect the long-run growth rate of output per worker.

What is the Golden Rule level of capital?

The steady-state level of capital that maximizes consumption per worker.

What condition must be met to achieve the Golden Rule steady state?

The marginal product of capital (MPK) must equal the depreciation rate ($\delta$).

An economy is considered 'dynamically inefficient' if its capital stock is _ the Golden Rule level.

above

If an economy is dynamically inefficient, how can it increase consumption both today and in the future?

By reducing the saving rate.

When population grows at a rate 'n', what is the new steady-state condition in the Solow model?

$s f(k) = (\delta + n)k$, where investment must cover both depreciation and capital widening.

In a Solow model with population growth but no technological progress, what is the steady-state growth rate of total output (Y)?

It grows at the rate of population growth, n.

In the Solow model, what term represents labor-augmenting technological progress?

A, where effective labor is defined as AL.

With technological progress 'a' and population growth 'n', what is the steady-state condition?

$s f(k) = (\delta + n + a)k$, where k is capital per effective worker.

In the full Solow model, what determines the sustained long-run growth rate of output per capita (Y/L)?

The rate of technological progress, 'a'.

In the full Solow model, what is the steady-state growth rate of total output (Y)?

The sum of the rate of technological progress and the rate of population growth (a + n).

What is the 'Solow residual'?

The portion of output growth that cannot be explained by the growth in capital and labor inputs, often interpreted as a measure of technological progress (TFP growth).

What is the 'convergence hypothesis'?

The idea that poorer economies (with lower k) should grow faster than richer ones and eventually catch up in terms of per capita income.

The observation that only countries with similar structural characteristics converge to similar steady states is known as _ convergence.

conditional

Besides physical capital, what are three other factors that can augment the Solow model to explain differences in production functions across countries?

Human capital, public infrastructure, and social infrastructure (institutions).

What is the consumption-leisure trade-off that individuals face when deciding how much labor to supply?

In order to consume more goods, individuals must work more, which means giving up leisure time.

A higher real wage has two opposing effects on an individual's labor supply: the effect and the effect.

substitution; income

Describe the substitution effect of a wage increase on labor supply.

The opportunity cost of leisure increases, incentivizing individuals to work more hours.

Describe the income effect of a wage increase on labor supply.

Individuals can afford more of all goods, including leisure, so they may choose to work fewer hours.

Why is the aggregate labor supply curve generally upward sloping even if some individuals' supply curves are not?

Because a higher wage will induce some people who were not working to enter the labor force.

How do firms determine their demand for labor?

They hire labor up to the point where the marginal product of labor (MPL) equals the real wage (w).

An increase in labor productivity (e.g., due to technological progress) will shift the labor demand curve in which direction?

To the right (or upwards).

In a perfectly competitive labor market model, all unemployment is considered _.

voluntary

What is involuntary unemployment?

A situation where individuals are willing to work at the going wage rate but cannot find a job.

What is the general cause of involuntary unemployment?

Wage rigidity, where the real wage is stuck above the market-clearing equilibrium level.

What are three major explanations for wage rigidity?

Collective bargaining by unions, wage regulations (like minimum wage), and efficiency wages.

What is the primary trade-off faced by a labor union during wage negotiations?

Achieving higher wages for its members versus securing more jobs (higher employment).

In the context of labor unions, who are the 'insiders' and 'outsiders'?

Insiders are employed union members who prioritize higher wages, while outsiders are the unemployed who would benefit from more jobs being available (at potentially lower wages).

What is an 'efficiency wage'?

A wage that employers voluntarily pay above the market-clearing level to boost worker productivity, reduce turnover, or attract higher-quality applicants.

Unemployment is a dynamic process with flows in and out. The change in the number of unemployed people ($\Delta U$) can be expressed as: $\Delta U$ = - .

$sL - fU$ (separations minus job finds)

What is the formula for the natural rate of unemployment ($u_n$) in terms of the separation rate (s) and the job-finding rate (f)?

$u_n = s / (s + f)$

The natural rate of unemployment is composed of which two types of unemployment?

Frictional unemployment and structural unemployment.

What is frictional unemployment?

Unemployment that results from the time it takes for workers to search for jobs that best suit their skills and tastes.

What is structural unemployment?

Unemployment that results from a fundamental mismatch between the number of jobs available and the number of people seeking jobs, often due to wage rigidity.