Question

(a) Oil prices have fallen by about a third since December of last year. Is this a positive
or a negative aggregate supply shock for China, a net importer of oil? Use the labor market and the
production function to predict the effects of lower oil prices on employment, output, and the real
wage in China. (b) Because of a decrease in the working-age population, Chinese labor force is now
shrinking (The Economist, Feb 23, 2019). How does this change your answers in (a) – if at all?

2)In 1990, Costa Rica and Jamaica had similar saving rates (around 20% of GDP) and
similar levels of income per capita (around $8,000 in 2005 dollars). In the 1990-2017 period, Costa
Rica’s saving rate remained around 20%, whereas Jamaica’s fell below 5%. Assume that multifactor
productivity increased the same in both countries over this period. (a) Use the Solow model to
predict the effects on the steady-state income per capita for both countries and compare. (b) In
2017, income per capita had risen to around $15,500 in Costa Rica, but was still $8,000 in Jamaica.
Is this consistent with your theoretical predictions from (a)?

Answer 1

1)Since the production function is linked with the labor market to determine full employment (or potential) output, anything that shifts the production function (which shifts labor demand) or the labor supply curve will affect potential output. ... The increase in employment leads to a higher level of potential output.

The decrease in the oil prices is a positive aggregate supply shock for China as China is the importer.

b) howsoever if the labour force is shrinking it will lead to lower level of potential output.