1 Question 11. Jim’s Nursery produces and sells $1100 worth of flowers. Jim uses nointermediate inputs. He pays his workers $700 in wages, pays $100 intaxes and pays $200 in interest on a loan. Jim’s contribution to GDP isA: 900 B: 1000 C: 1100 D: 1800Answer: (C) - the contribution is exactly what Jim sold minusthe intermediate inputs he used which are zero. Ask yourself,where are the $1000 that are missing from the payments2. All of the following increase total factor productivity except A) new in-ventions. B) more capital. C) new management techniques. D) favorablechanges in government regulations.Answer: (B) -TFP measures the efficiency with which the factorsof production (such as capital and labor) produce output so itcannot be an actual factor of production.3. We can express the per-worker production function as a function of onlyper-worker capital thanks to A) the decreasing marginal return of capital.B) the decreasing marginal return of labor. C) the constant returns toscale. D) the impatience of households.Answer: (C) -To convince yourselves try to do this when theproduction function is: Y = Kα∗ Nβwhen α + β is not equal to 14. Assume two firms that produce a single good in an economy with a con-stant returns to scale Cobb-Douglas production function. If N1 > N2,then the allocation is necessarily inefficient: True/False? Why?Answer: (False) - Then can have different capital stocks thatwould make their marginal productivities of labor being thesame and thus efficient.Question 2Argue whether the following statements are “True, False, or Uncertain.” andexplain your answers. All of these question relate to the basic Solow growthmodel we discussed in class:11. A higher savings rate increases the economy’s growth rate forever.Answer: (False) - Only temporarily2. A higher savings rate increases the economy’s growth rate temporarily.Answer: (True) - Only temporarily3. Consider two economies with a cobb-douglas produciton function that areidentical in all of their parameters - (s, δ, n, A, α). Economy 1 has a lowerinitial amount of capital than Economy 2. Then(a) Economy 1 will grow faster than Economy 2Answer: (True) - The MPK is higher when there is lesscapital so this economy will accumulate capital faster thaneconomy 2 and thus grow faster.(b) Eventually Economy 1 will converge to Economy 2Answer: (True) - Given that they have the same parametersthey will converge to the same steady stateQuestion 31. Consider a one-time change in the level of the labor force in an economy(such as due to a new generous immigration policy). Specifically, assume itrises permanently and immediately (i.e. over a very short period of time)from N to N’. This is the only change in the economy. Assuming theeconomy starts in its initial steady state use the Solow model to explainwhat happens to the economy in the following questions.(a) What happens to the capital per person immediately as the laborforce increases from N to N’?Answer: It falls. When the new workers arrive the stock ofcapital is given and cannot be changed immediately(b) What happens to the output per person immediately as the laborforce increases from N to N’?Answer: It falls. Since capital per worker falls then outputper works must fall2(c) What happens to the capital per person in the long run once theeconomy reaches to the new steady state (relative to the capital perperson that was before the increase in the labor force)?Answer: It goes back to the original steady state value(d) What happens to the output per person in the long run once theeconomy reaches to the new steady state (relative to the capital perperson that was before the increase in the labor force)?Answer: It goes back to the original steady state value(e) What happens to the growth rate of output per person while theeconomy is moving towards its new steady state relative to the growthrate it has before the change?Answer: It is positive and thus higher than the steady statevalue. As the economy converges back to the steady statethe growth rate of the economy, while being positive, de-clines until it stops when the eonomy reaches to the steadystate(f) What happens to the growth rate of output per person in the longrun once the economy reaches to the new steady state relative to thegrowth rate it has before the change?Answer: It goes back to the original steady state value, i.e.a zero growth rate2. Consider a Solow economy that begins with a capital stock of $10 andsuppose its steady state level of capital is $20. The economy then receivesa gift of foreign aid worth $5 of capital which can be put into productionright away(a) How would the foreign aid affect the eventual steady state consump-tion (relative to the steady state consumption that would have oc-curred absent a foreign aid?Answer: It will not effect3. Consider a Solow economy that is at its steady state with a capital stockof $20. The economy then receives a gift of foreign aid worth $5 of capitalwhich can be put into production right away.3(a) How would the foreign aid affect the eventual steady state consump-tion (relative to the steady state consumption that would have oc-curred absent a foreign aidAnswer: It goes back to the original steady state value so itwill have no effect(b) What can you say about the path of consumption over time followingthe aid until the economy gets back to its steady state?Answer: As there is more capital then the steady state andthe savings rate did not change then the is more consump-tion than the steady state. So consumption will jump "up"and then as capital converges back to the steady state it willdecline back to its original value (while still being above itas it converges back)4. Assume there was variation in GDP per capita in 1950, and completeunconditional convergence by 2000. Make up data consistent with thisobservation for 3 countries, and plot what this might look like in a diagram(scatter plot) where: (1) GDP per capita in 1950 is on the horizontal axis:(2) GDP per capita in 2000 is on the vertical axis; and (3) each “dot” is acountry.Answer: You will draw it as three dots on a straight line (i.e.horizontal, parallel to the X-axis)5. Consider a Solow model where the production function is nowYt= AKt(a) Assume that A is smaller than the depreciation rare δ. What doesoutput in the steady state equal to?Answer: It depends on whether sA > δ in which case thereis no steady state or alternatively if sA < δ then the onlysteady state is one