# > Econ 100b Created 4/30/1996 Go to Brad De Long's Home Page P-Set Eight Answers

## Long Run Growth

Economics 100b; Spring 1996; Brad DeLong

1. What does it mean for an economy to have constant returns to scale?

• It means that if you double all the inputs used in production, output doubles as well.

2. How can you tell whether or not an economy in steady-state growth is at the "Golden Rule" level of saving and the capital stock?

• Is the marginal product of capital r = aK/Y = n + g + d, the required gross investment for the economy, the sum of the depreciation rate, the labor efficiency growth rates, and the labor force growth rate? If so, then the economy is at the "golden rule".

3. Why might you think that the "Golden Rule" level of saving and the capital stock is a good place for an economy to be?

• It is a pareto-optimal distribution of consumption across points in time. That is, there is no alternative that leaves consumption higher at every point in time.

4. What do you think were the principal causes of the productivity slowdown of the 1970s?

• A slowdown in the rate of improvement of the efficiency of labor (rather than a slowdown in investment). The reduction in the rate of technological progress had many partial causes, but in bulk in remains a mystery.

5. Suppose that an economy's production function is Y = K0.5(EL)0.5 ; suppose further that the savings rate is 40% of GDP, that the depreciation rate d is 4% per year, the population growth rate n is 0% per year, and the rate of growth g of the efficiency of the labor force is 2% per year. What is the steady-state capital-output ratio? What are the steady-state levels k* of the capital stock per unit of labor power (or per efficiency unit of labor) and y* of output per unit of labor power?

• steady-state capital-output ratio = 40/6 = 6.67; steady-state k* = 44.44; steady state y*=6.67

6. Suppose that all variables are the same as in problem 5 save the production function, which instead is: K0.8(EL)0.2 ; how would your answers be different? Can you briefly explain why your answers are different?

• the steady state capital-output ratio remains the same: 6.67; So we have:
y = k/6.67 = k0.8 , which implies that:
k0.2 = 6.67 , or:
k = 6.675 = 13,168.7243
y = k0.8 = 1975.30864

Why are the second results so different, so--enormous? Because the larger is a, the share of capital in the production function, the slower do diminishing returns to investment set in because each marginal unit of capital produces almost as much extra output as the previous unit of capital. And it is diminishing returns to capital investment that ultimately lead the capital stock and output per unit of effective labor to converge to their steady states.

7. Japan has had a very high savings rate and a high growth rate of output per worker over the past half century, starting from an initial post-WWII very low level of capital per worker. What does the analysis of chapter 4 suggest about Japan's ability to sustain a higher growth rate than other industrial countries?

• That Japan has grown very fast as it has "converged" to the steady-state growth path characteristic of industrial economies. And that in the future Japanese growth will look much more like that of the typical industrial economy.

8. For what reasons might it make sense for the government to adopt a "technology policy", and subsidize investment in certain areas?

• Since the bulk of the social benefits from new inventions and innovations are not the permanent property of the inventor but diffuse widely through society, the marginal private benefits is less than the marginal social benefit--hence a competitive market system will tend to generate "too little' in the way of inventions and innovations, hence a strong case for government subsidy.

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# Econ 100b

Created 4/30/1996
Go to
Brad De Long's Home Page

 Professor of Economics J. Bradford DeLong, 601 Evans University of California at Berkeley Berkeley, CA 94720-3880 (510) 643-4027 phone (510) 642-6615 fax delong@econ.berkeley.edu http://www.j-bradford-delong.net/

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