Spring Term 2017 Yaşar University

Introduction to Economics II (Econ 102)

Problem Sheet 3

Production and Growth

1) What, in general, are the potential sources of economic growth?

2) What does the level of a nation’s GDP measure? What does the growth rate of GDP measure?
Would you rather live in a nation with a high level of GDP and a low growth rate or a nation with a
low level of GDP and a high growth rate?

The level of a nation’s GDP measures both the total income earned in the economy and
the total expenditure on the economy’s output of goods and services. The level of real
GDP is a good gauge of economic prosperity, and the growth of real GDP is a good
gauge of economic progress. You would rather live in a nation with a high level of GDP,
even though it had a low growth rate, than in a nation with a low level of GDP and a high
growth rate, since the level of GDP is a measure of prosperity.

3) List and describe four determinants of productivity.

The four determinants of productivity are: (1) physical capital, which is the stock of
equipment and structures that are used to produce goods and services; (2) human capital,
which consists of the knowledge and skills that workers acquire through education,
training, and experience; (3) natural resources, which are inputs into production that are
provided by nature; and (4) technological knowledge, which is society’s understanding of
the best ways to produce goods and services.
Y /L = A F (1 , K /L , H /L , N /L )

4) In what way is a college degree a form of capital?

A college degree is a form of human capital. The skills learned in earning a college
degree increase a worker's productivity.

5) Explain how higher saving leads to a higher standard of living. What might deter a policymaker
from trying to raise the rate of saving?

Higher saving means fewer resources are devoted to consumption and more to producing
capital goods. The rise in the capital stock leads to rising productivity and more rapid
growth in GDP for a while. In the long run, the higher saving rate leads to a higher
standard of living. A policymaker might be deterred from trying to raise the rate of
saving because doing so requires that people reduce their consumption today and it can
take a long time to get to a higher standard of living

6) How does the rate of population growth influence the level of GDP per person?
The higher the rate of population growth, the lower is the level of GDP per person,
because there's less capital per person, hence lower productivity.

7) Does a higher rate of saving lead to higher growth temporarily or indefinitely?

A higher rate of saving leads to a higher growth rate temporarily, not permanently. In the
short run, increased saving leads to a larger capital stock and faster growth. But as
growth continues, diminishing returns to capital mean growth slows down and eventually
settles down to its initial rate, though this may take several decades.

8) Suppose that factory output rose from 50,000 units to 55,000 units while labor hours rose from
1100 to 1200. What can you say about productivity? Did it rise or fall?

9) Describe three ways in which government polşcymaker can try to raise growth in living standards in
a society. Are there any opportunity cost to these policies?

Ways in which a government policymaker can try to raise the growth in living standards
in a society include: (1) investing more current resources in the production of capital,
which has the drawback of reducing the resources used for producing current
consumption; (2) encouraging investment from abroad, which has the drawback that
some of the benefits of investment flow to foreigners; (3) increasing education, which has
an opportunity cost in that students are not engaged in current production; (4) protecting
property rights and promoting political stability, for which no drawbacks are obvious; (5)
pursuing outward-oriented policies to encourage free trade, which may have the
drawback of making a country more dependent on its trading partners; (6) reducing the
rate of population growth, which may have the drawback of reducing individual freedom
and lowering the rate of technological progress; and (7) encouraging research and
development, which (like investment) may have the drawback of reducing current
consumption.

10) According to the catch-up effect:

a) countries that start off poor tend to grow more rapidly than countries that start off rich
b) countries that start off poor tend to grow less rapidly than countries that start off rich
c) nations with relatively high living standards grow faster than nations with lower living
standards
d) countries that start off rich undertake more investment than countries that start off poor

Definition of catch-up effect: the property whereby countries that start off poor tend
to grow more rapidly than countries that start off rich.

11) Use “the rule of 70” to answer the following questions. Suppose the real GDP/person in Turkey
grows at an annual rate of 2% and the real GDP/person in India grows at an annual rate of 1%
a) How many years does it take for real GDP/person to double in Turkey?
b) If real GDP/person in Turkey is $2000 in 1935, how much will it be in the year 2005?
c) How many years does it take for real GDP/person to double in India?
 d) If real GDP/person in India is $2000 in 1935, how much will it be in the year 2005?
e) Use the numbers you calculated above to help explain the concept of compound growth.

a) 70/2=35 years
b) 2005-1935= 70 years. So it will double two times in 70 years =$8000
c) 70/1=70
d) $4000
e) Turkey adds $2000 to its GDP in first 35 years. Growing at the same percent, it
adds $4000 to its GDP over 35 years because the same growth rate is now applied
to a larger base.