NOVA School of Business and Economics

Fall Semester 2022/2023

Principles of Macroeconomics
2nd Problem Set

Group 1

1.

a)

Graph 1 - GPSA: Growth rate based on seasonally adjusted volume data,

percentage change on the previous quarter
NOVA School of Business and Economics

Fall Semester 2022/2023

The Real GDP for India, China and the United States has decreased in 2019 and they
have achieved a recession, because of the pandemic. However, since China is a
“closed” economy, the pandemic crisis haven’t been felt so much in this country, they
only had a slowdown in income. A crisis happened in the 2000s affected the United
States and Italy. The Real GDP growth is more constant in the United States but less
and even decreasing in Italy.

b)

From 1960 until 2008, the variation of the increase in the GDP per capita was similar for
each one of the countries mentioned. However, since this year, only China and India
have increased exponentially. In fact, Italy and the United States maintained the GDP
per capita more constant. (Graph from the question 2a).
NOVA School of Business and Economics

Fall Semester 2022/2023

c)

∑ (Real GDP p/capita Annual Average

growth) (%)

China 401% 401/60=6,7%

United States 117,6% 117,96/60=1,96%

Italy 123,1% 123,1/60=2,05%

India 185,2% 185,2/60=3,09%

NOVA School of Business and Economics

Fall Semester 2022/2023

60's (%) 70's (%) 80's (%) 90's (%) 00's (%) 10's (%)

China 11 52,9 81,7 87,6 96,9 70,9

United
States 30 21,1 21,7 19,8 9,5 15,5

Italy 45,2 34,9 24,8 14,7 1,7 1,8

India 16 5,9 33,4 37,3 46 54,1

From 1960 until 1970, China was the most unstable country in the GDP per capita
growth rate, as shown in the graph 2 and it increased on an average from about 11%.
Per decade, it has been always increasing until the decade from 2010 to 2019, where it
decreased about 17%. In fact, China has the highest annual average GDP per capita
growth rate, from about 6,7%.

India has an annual average of GDP per capita growth of about 3,09%. Since the 80’s
the GDP per capita growth is always increasing.

On the other hand, Italy is the only country from these examples which is decreasing its
GDP per capita growth since the decade of the 60's. However, it has an annual average
of about 2,05% of GDP per capita growth, a higher value compared to the annual
average of the GDP per capita growth from the United States, which is about 1,96%.
This means that, even though the United States has a decade average GDP per capita
growth rate higher than Italy, it has a lower annual average GDP per capita growth.

In conclusion, since Italy and the United States are the countries where the annual
average GDP per capita growth rate is lower, they are the ones with the more constant
GDP per capita.
NOVA School of Business and Economics

Fall Semester 2022/2023

2.

Graph 2 – Real GDP per capita (constant LCU)

China is converging into the same values of the Real GDP per capita in two main years.
These are examples, in 2008 when it achieved Italy, and then in 2019 the United States.
India is also increasing its Real GDP per capita by equalling the United States in the
2000’s. However, on the other hand, the United States and Italy are not converging to
any of these four countries, because their Real GDP per capita is constant.

As in the “Rajaiah, Jayaraj and Pendse, Eesha and Thomas, Sheril Anna and Agrawal,
Shubh and Shetty, Tejas, A Study on Forecasting Economic Convergence of India in
Comparison to USA, China and Japan (July 17, 2021)” article, in page 31 they “suggest
that in the group of 4 countries we have selected, there is a presence of economic
convergence pattern, as during the initial two decades from 1979 - 89 & 1989 -99, the
GDP growth rate of the developed nations is much faster than the developing countries,
whereas after 1999, the GDP growth rate of India catches up with that of US and Japan.
The GDP growth rates of India after 1999 are much faster as compared to US & Japan.
In the case of China, the catching-up effect takes place after 1989, as after that the
GDP growth rate of China is much higher than the growth rates of the US and Japan
and in both cases, these trends continue to exist even in 2029.”
NOVA School of Business and Economics

Fall Semester 2022/2023

In conclusion, even though the article refers to Japan instead of Italy, the results are not
very divergent from the convergence from India and China.

II
1.

For many years the biggest economies in the world like the US and China had
been growing at an astronomic pace. Although, as we all know they are slowly
moving towards stagnation. As a result, great investors are searching for an
economy that will bring higher growth rates as a lever for the success of their
investments.

India, the second most populated country with almost 1.4 billion people, has
always been a huge economy with enormous growth potential. What triggered
the attention of investors was the change in some domestic policies. These
domestic changes directly influenced India inside borders and many economies
on a global scale, because of India’s potential for growth and weight in the world
economy, due to its huge labor force. Instead of redistributing the capital
resources to the economy, the new policy prioritized investment and job creation
as a source of economic growth. A clear example of this was the introduction of
goods and services tax which strengthened the domestic private sector because
taxes are the main source of revenue to fund public spending on education,
health care, and infrastructure, among others. Another great example, as well as
the corporate tax cuts, was the “production-linked schemes to incentivize
investment from both within and outside India’s borders”.

The new policies boosted India’s disposable income which was used to
potentialize the productivity of workers and to invest in digital infrastructures.
That greatly impacted pandemic times when remote work had its value suddenly
increased. The rise in the education, health care, physical and digital
infrastructures levels, given by the new policies, led to an increase in the
NOVA School of Business and Economics

Fall Semester 2022/2023

productivity of the labor force and investments in areas needed desperately by

the world, that increase radically the demand for India’s workforce.

Following the Parkin Growth model, on the one hand, the creation of new jobs,
the investment in human capital and, consequently, continuous technological
progress, will increase the aggregate of worked hours and, most importantly, the
productivity of the labor force. Therefore, the aggregate labor demand will shift to
the right as a sign of its rising, making the labor market equilibrium rely on a
higher level of hours worked and real wage. Being more productive and having
more money to spend, people will consume more and save more, which shift the
aggregate production function upwars, increasing the real GDP and its potential.
NOVA School of Business and Economics

Fall Semester 2022/2023

2.

Identifying the expansion in the working-age population does not really affect our
previous answer about the increase in the demand for India’s workforce. In this
case, the growth of the working-age population make a right shift in the
aggregate labour supply curve, which for itself diminishes the real wage. The real
wage it’s not defined only by the supply of labor because it also relies on the
demand side, which we approached in the previous question, therefore the
decrease in the real wage is compensated by the demand curve. Once again,
this factor also pushes the aggregate of hours worked that make the real GDP
increase, but from a supply side. More people able to work legally means an
increase in production, in other words, a bigger output by the economy. As in the
previous answer the conclusion is the same, the real GDP is going to increase,
as shown by the graph below.
NOVA School of Business and Economics

Fall Semester 2022/2023

3. First of all, it’s necessary to understand that an increase in productivity basically

means that for the same amount of capital and labor, there is more output being
produced.

Starting with the Solow model, it considers the output p/worker (y) of an economy to be
a function of capital p/worker (k) multiplied by technological advance (A), (assuming: we
are in a closed economy; depreciation is a constant proportion of capital; population
growth is constant; there are diminishing marginal benefits). Knowing that capital is a
stock variable that is affected by investment and depreciation, and that, because we are
in a closed economy, I=S=s.y, (savings are a constant proportion of output), we obtain a
graph like “graph3”, in which the intersection between (δ+n)k (population
growth+depreciation as a proportion of capital) and s.y gives us the steady state in
which savings are exactly enough to cover depreciation. Using the amount of k of the
steady state, we get y. .

In “graph4”, we can see how the increase in productivity affects this model. It generates
a new output function (red) and, as savings are a constant proportion of y, there is also
a new s.y line (blue), which will intercept (δ+n)k at a higher value of k, giving us a new
steady state and, therefore, a higher potential output. With this, in the short run,
investment will be higher than depreciation, generating capital creation, making
investment and depreciation converge into the new steady state and output to the
potential output (green/red arrows), in the long run.

Now, considering Parkin’s model, it states that Y is a function of Labour (L), so, by using
the labor market we obtain the amount of labor in full employment (where labor demand
intersects labor supply). Selecting this amount of labor in the function, we obtain the
potential GDP.

In this model, the increase in productivity originates, once again, a new function
(previous question graphs), which allows a higher potential GDP at full employment
and, therefore, in the long run, the real GDP will converge to the new potential GDP.

So, applying these models to India’s case, we predict that, in the long run, the Indian
Real GDP per/capita will increase, converging to the new potential GDP per/capita,
therefore, the Real GDP per/capita growth rate will be positive until Real GDP catches
up with potential GDP, becoming 0% when that happens.
NOVA School of Business and Economics

Fall Semester 2022/2023

Graph 3

Graph 4
NOVA School of Business and Economics

Fall Semester 2022/2023

4.

There are many different drivers that may influence potential GDP growth.
Potential GDP is calculated by measuring what the real GDP would look like if
the country was at full employment. With that being said, the main factor nudging
India’s potential GDP upward, is the fact that the median age in India is
substantially smaller than that of China (‘India’s median age today is 11 years
younger than China’s’), this means a bigger amount of people enters the labor
force every year and therefore a higher potential GDP growth rate. On the other
hand, another factor that would implicate increasing growth rates in potential
GDP is the increase in technological development and industrialization (‘[...] new
factories and offices of the world will draw more employment into the formal
sector and more crucially raise productivity growth, creating a virtuous cycle of
sustained growth.’). By catching and increasing foreign investment, India will be
able to maximize potential GDP, due to the fact that factories and services will
employ more people, and increase average income, boosting GDP exponentially
and increasing average population living conditions. By conciliating both an
increasing workforce, and an increasing real GDP, we have the two factors that
potential GDP takes into account. This obviously means that potential GDP
growth rate hikes up and justifies the indian economic potential, as well as why it
will keep on booming.

Resources:

➔ China embraced commodity economy in 1984 - Business - Chinadaily.com.cn

➔ A Study on Forecasting Economic Convergence of India in Comparison to USA, China and Japan by
Jayaraj Rajaiah, Eesha Pendse, Sheril Anna Thomas, Shubh Agrawal, Tejas Shetty :: SSRN