2009/2010

EC1301 Principles of Economics

Semester 1

Tutorial 7 suggested answers

Q1. Growth rate of real GDP, real GDP per worker and real GDP per capita were 7.8%, -1.3% and 3.3% respectively. How you judge the performance of the country thus depends on which indicator you use. Overall size of the economy grew very fast, but each persons share grew much slower, and labour productivity actually declined. You may be interested to know that the data refers to Singapore. 2007 was a year of high growth, but it was achieved by a massive increase in the number of employed (+9.2%), fuelled by a big inflow of foreign labour.

Q2. This is a question designed to provoke discussion only, and there are no set answers. Students may feel free to put this question aside when doing revision for examinations. The following table shows some answers that students came up with:

Q3 (a) The first thing to note is that you are to approximate, so use the Rule of 70! By that rule, Sinostans real GDP doubles every 7 years, while Ameristans real GDP doubles every 14 years. Second thing to note is that we are looking at size of economy, so the measure to use should be real GDP. Sinostan starts at a real GDP level of 1.2 billion x $6,000 = $7.2 trillion, while Ameristan starts at a real GDP level of 300 million x $48,000 = $14.4 trillion.

2009/2010

EC1301 Principles of Economics

Semester 1

Simply count what Sinostans real GDP becomes every 7 years and what Ameristans real GDP becomes every 14 years. You will find that in 14 years 1, both countries will reach $14.4 trillion and Sinostan will have caught up with Ameristan.

Q3 (b) Here, we are looking at living standards, so the measure to use should real GDP per capita. Fortunately, because both countries have populations that are constant in size, growth rates of real GDP per capita are the same as growth rates of real GDP. Thus, Sinostans real GDP per capita doubles every 7 years, while Ameristans real GDP per capita doubles every 14 years. The starting points are $6,000 for Sinostan and $48,000 for Ameristan. Simply count what Sinostans real GDP per capita becomes every 7 years ($12,000 after 7 years, $24,000 after 14 years, $48,000 after 21 years and so on) and what Ameristans real GDP per capita becomes every 14 years ($96,000 after 14 years, $192,000 after 28 years, and so on). You will find that in 42 years 2, both countries real GDP per capita will reach $384,000 and Sinostan will have caught up with Ameristan.

Q4. D. A trade deficit means borrowing from abroad, which has to be repaid in the future. If the borrowing is used to increase investment, then in the future the economy has grown and will be able to repay the debt (by running a trade surplus) and still have higher future consumption. But if the trade deficit is used to increase consumption, there is no economic growth, and in the future the country can only run a trade surplus by reducing future consumption. Thus, none of the options A, B or C always occur with a trade deficit.

Q5. D. Depreciation is generally a stable percentage of the capital stock. If you have 100 machines, 10 are going to need replacement next year. If you have 1,000 machines, 100 are going to need replacement next year. Thus, the higher the capital stock, the more depreciation occurs. Consequently, for any given amount of gross investment, the actual addition to capital stock (net investment) becomes smaller and smaller because the amount set aside to replace depreciated capital gets bigger and bigger.

The exact answer (not required for exam purposes) is 14.9 years, obtained by solving the following equation n n for n: 7.2(1.1) = 14.4(1.05) 2 The exact answer (not required for exam purposes) is 44.7 years, obtained by solving the following equation n n for n: 6,000(1.1) = 48,000(1.05)

2009/2010

EC1301 Principles of Economics

Semester 1

Q6. D. Diminishing returns apply when you add more workers to a given amount of capital, and also when you add more capital to a given number of workers.

Q7. The 16 chosen countries are all currently developed. 3 Thus, as long as they were somewhat dissimilar in per capita income in 1870 (very likely), one is bound to get some convergence. In other words, the sample is biased towards finding convergence. If a large, more representative set of countries is used (data problems restrict most such studies to 1960 as the starting point), the best fit line turns out to be horizontal, meaning there is no relationship between 1960 real GDP per capita and growth rates after 1960. Poor countries are just as likely to grow faster, slower, or at the same speed as rich countries, and thus there is no convergence.

Q8. D. Growth accounting is concerned with accounting for past growth, not projecting into the future.

Q9. A. The other 3 choices are all unambiguously good for technological progress. But long lasting patents may be good (strong incentives for firms to innovate and create knowledge) or bad (slows down the spread of knowledge).

Q10. B. The other choices may perhaps help economic growth, but they do not involve getting incentives right. Please refer to the textbook, which gives a good account of getting incentives right.

Q11. Thailand and Myanmar are compared because they are neighbours, and have rather similar geography and culture. But Thailand turned to market orientation and openness to foreign trade and investment far earlier than Myanmar, which tried central planning instead. Thus, Thailand grew far more rapidly. Only after 1994 did Myanmar begin to open itself to foreign trade and investment.

The countries are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Japan, Netherlands, Norway, Sweden, Switzerland, United Kingdom, and United States.

2009/2010

EC1301 Principles of Economics

Semester 1

Q12. The Gapminder visual is showed in the figure below:

Botswana and Papua New Guinea are compared because they both are rich in natural resources and were extremely poor in 1960. But Botswana has had excellent political stability and rule of law, and consequently has been one of the fastest growing economies in the world over the last 50 years, demonstrating that high growth is possible even in Africa. (Note: by the mid 1990s, the AIDS epidemic began pulling down Botswanas life expectancy and raising its unemployment rate) Papua New Guinea has serious problems with political stability and corruption, and has thus not managed to take advantage of its natural resource abundance. Moral of the story: having natural resources does not help if the economic environment isnt right.