Test Item File 3: Principles of Macroeconomics 18(31) Long-Run Growth The Growth Process: From Agriculture to Industry1. Define economic growth.Economic growth is an increase in the total output of an economy. It is defined by some economists as an increase of real GDP per capita.Difficulty: E Type: D2. What is modern economic growth?Modern growth is the period of rapid and sustained increase in real output per capita that began in the Western World with the Industrial Revolution.Difficulty: E Type: D3. Identify and explain the two basic forms of capital?The two basic forms of capital are physical and human. Material things that are used in the production of goods and services represent physical capital. Human capital includes knowledge, skills, and talents.Difficulty: E Type: F340Test Item File 3: Principles of Macroeconomics4. Draw a graph illustrating economic growth using the production possibilities frontier. Label the horizontal axis “capital goods” and the vertical axis “consumer goods.”Difficulty: E Type: A5. Answer the following questions by analyzing the following production possibilities frontier.(a) Explain what is happening in the economy at Point A. How can the economy move to a point on ppf1?(b) Why will producing investment goods today cause different results for the future ofthe economy than focusing more on consumer goods today?(c) How would any nation move to higher and higher production possibilities frontiers? For example, moving from ppf1 to ppf2. (a) At a point like A, the economy is in a recession. To get out of the recession and move to a point on the production possibilities frontier would require either expansionary fiscal or monetary policy. (It is also possible to do this by using resources more efficiently.)341Chapter 18 (31): Long-Run Growth (b) A strategy that favors investment goods over consumer goods will lead to a much faster shift in the ppf. A strategy that favors consumption over investment will lead to a higher standard of living, but a slower rate of growth.(c) In order to move to a higher production possibilities frontier a nation must achieve economic growth or, in other words, more output of all goods and services. In our example, to move from ppf1 to ppf2, this country would have to be able to produce more of both investment and consumer goods. This might occur if there were technological changes that allowed the nation to produce more goods or if there were more labor and capital. Difficulty: M Type: C6. Answer the following set of questions, given the production schedules for the computer chip industry and the clothing industry.(a) Calculate the labor productivity in the computer chip industry for years 1-4.(b) Calculate the labor productivity in the clothing industry for years 1-4.(c) Compute the growth rate for both industries for years 1-4.(d) Compare the productivity and growth of the computer chip industry and the clothing industry. Explain the differences. (a) Labor productivity is calculated by taking Y/L. Thus, in year 1 Y/L = 4.5, in year 2 Y/L = 4.52, in year 3 Y/L = 4.6, and in year 4 Y/L = 4.7.(b) Labor productivity is calculated by taking Y/L. Thus, in year 1 Y/L = 2, in year 2 Y/L = 1.91, in year 3 Y/L = 1.76, and in year 4 Y/L = 1.6.(c) The growth rates in the computer chip industry are as follows: year 1-2: 5.5%, year 2-3: 5.7%, and year 3-4: 6%. The growth rates in the clothing industry are as follows: year 1-2: 5%, year 2-3: 4.7%, and year 3-4: 4.5%.(d) In the computer chip industry both output and capital are increasing faster than labor, so productivity and output growth are growing. Output growth in the computer chip industry is growing, whereas output growth is falling in the clothing industry. In the clothing industry labor is growing faster than capital and output and, therefore, output growth and productivity are declining. Difficulty: D Type: AThe Sources of Economic Growth7. Given the following production information, answer the next set of questions.342Test Item File 3: Principles of Macroeconomics(a) Calculate labor productivity for all three years.(b) Explain whether labor productivity is increasing or decreasing and why.(c) What theory explains the trend exhibited in this production table? (a) Labor productivity is calculated by taking Y/L. In year 1 Y/L = 20/5 = 4, in year 2 Y/L = 22/6 = 3.66, and in year 3 Y/L = 23/7 = 3.29.(b) Labor productivity is falling because labor is increasing, whereas the capital stock is remaining constant. Because the capital stock is constant, new labor is not as productive as old labor and, therefore, productivity will fall and there will be a lower standard of living.(c) This idea is called the theory of diminishing returns to a factor. Diff: 3 Type: A8. Explain how an economy can grow without increases in the labor force and physical capital. Increases in productivity allow the same amount of resources to produce more. Hence, an increase in productivity causes economic growth, even without increasing labor and/or capital. Difficulty: M Type: A9. Explain the role of inventions and innovations in creating economic growth. Inventions are advances in knowledge and innovations are the use of new knowledge to produce new products. Invention by itself will not generate economic growth. It takes invention combined with innovation to generate growth. Difficulty: E Type: C10. Explain some of the reasons given for the productivity decline in the United States in the 1970s. Answers will vary. Some of the reasons given for the low rate of productivity in the 1970s are the low savings rate in the United States, increased environmental and government regulation on businesses, the lack of research and development, and that high energy costs in the 1970s diverted investment resources away from other investment projects. Difficulty: E Type: F343Chapter 18 (31): Long-Run Growth 11. Explain the three different ways an increase in GDP can come about. An increase in GDP can come about in three ways: (1) through an increase in labor, (2) through an increase in physical or human capital, or (3) through an increase in the amount of product produced by each unit of capital or labor. Difficulty: E Type: D12. Explain the difference between an invention and an innovation. Provide an example of an invention and an innovation. An invention is an advance in knowledge. An innovation is the use of new knowledge to produce a new product or to produce an existing product more