Question

A6-9. Suppose the aggregate production function for an economy is given by Y* = (T+H)K1/2L1/2, where Y* is potential GDP, T is the average level of technology, H is the average level of human capital, K is the capital stock and L is the labour force. Assume initially that both T and H equal 5, and that both K and L equal 64. Assume that the population grows at the same rate as any growth in the labour force so that we can interpret any change in average product (Y*/L) as a change in per capita GDP.

(a) Given the initial values for the variables, calculate Y* and Y*/L. [3]

(b) Suppose that the country is subject to balanced growth where both the K and L increase to100. What happens to both Y* and Y*/L? Does this aggregate production function exhibit “constant returns to scale” (CRS)? [4]

(c) Suppose instead that growth is driven only by an increase in L from 64 to 100. What happens to both Y* and Y*/L? [3]

(d) Now suppose that growth is driven only by an increase in K from 64 to 100. What happens to both Y* and Y*/L? [3]

(e) Now suppose that growth is driven not by any increase in the factors of production, but rather by increases in both T and H from 5 to 6.25. What happens to both Y* and Y*/L? [3]

(f) Suppose you lived in this country. Rank the kinds of economic growth described in parts (b)-(e) in terms of which you would prefer to see happen. [4]

Answer 1