U6301 Macroeconomics for International and Public Affairs Martsella Davitaya

Columbia University | SIPA Sigga Benediktsdottir

Problem Set #2
Suggested Solutions
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Deadline. 11:59 pm Feb 6, 2024
Instructions. The electronic version (either scanned or typed up) of solutions must be uploaded to
CourseWorks by the indicated deadline. Solutions submitted after the deadline will receive 0 points.
Solutions can be submitted individually or by a group of up to 4 students. You can work in a group
with students from different sections. If you work in a group, please indicate all names and UNI-s on
top of the first page.
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Problem 1. According to our aggregate production model with 𝑌 = 𝐴𝐾 𝛼 𝑁1−𝛼 and output per worker
𝑌 𝐾 𝛼
= 𝐴 (𝑁) , how would each of the following affect i) the current level of national output and ii) GDP
𝑁
per capita? Explain.
a) Energy supplies become depleted.

If energy supplies become depleted, this is likely to reduce productivity, because energy is a factor of production.
So, the reduction in energy supplies reduces full-employment output.
Similarly, the average output decreases as the national output decreases and the population remains unaffected.

b) New teaching techniques improve the educational performance of high school students.

Better education raises future productivity and output, but has no effect on current full employment output if
high schoolers are not part of the current labor force.
Similarly, it would neither affect GDP nor GDP per capita until high school students graduate and enter the
labor force.

c) A new law mandates the shutdown of some unsafe forms of capital.

This reduction in the capital stock reduces full-employment output (although it may very well increase social
welfare).
The reduction in capital would reduce capital per capita and therefore also GDP per capita.

d) A country's population is growing.

If the increase in the population increases the labor force, then it would increase employment and full-employment
output. If not, for example the birth rate is growing or child mortality falling, then total output would, be
unaffected until these growing younger cohorts would, enter the labor force.
If the population grows, but the labor force remains constant, then GDP per capita would fall as total output does
not change and the denominator is higher. If the labor force increases, then the productivity of the new workers
is lower than that of previous workers (and than the average output per worker) because of diminishing returns
to labor, and GDP per capita will fall in population/labor.
Problem 2. The average growth rate of real GDP from 1950 to 1992 was 3.2%, the capital grew at rate
2.6%, whereas Civilian employment at rate of 1.4%.
a) Assuming that the U.S. aggregate production function is 𝑌 = 𝐴𝐾 0.3 𝑁 0.7, estimate the growth rate
of productivity, A.

One can derive growth equation using by applying natural logs to the production function:
𝑙𝑛 𝑌𝑡 = 𝑙𝑛 𝐴𝑡 + 𝑙𝑛 𝐾𝑡0.3 + 𝑙𝑛 𝑁𝑡0.7
𝑙𝑛 𝑌𝑡 = 𝑙𝑛 𝐴𝑡 + 0.3 𝑙𝑛 𝐾𝑡 + 0.7 𝑙𝑛 𝑁𝑡 (1)
The same equation holds in 𝑡 − 1:
𝑙𝑛 𝑌𝑡−1 = 𝑙𝑛 𝐴𝑡−1 + 0.3 𝑙𝑛 𝐾𝑡−1 + 0.7 𝑙𝑛 𝑁𝑡−1 (2)
Subtracting (2) from (1):
𝑙𝑛 𝑌𝑡 − 𝑙𝑛 𝑌𝑡−1 = 𝑙𝑛 𝐴𝑡 − 𝑙𝑛 𝐴𝑡−1 + 0.3(𝑙𝑛 𝐾𝑡 − 𝑙𝑛 𝐾𝑡−1 ) + 0.7( 𝑙𝑛 𝑁𝑡 − 𝑙𝑛 𝑁𝑡−1 )

Recall that 𝑙𝑛 𝑌𝑡 − 𝑙𝑛 𝑌𝑡−1 ≈ 𝑔𝑌 . Then

𝑔𝑌 = 𝑔𝐴 + 0.3𝑔𝐾 + 0.7𝑔𝑁
Applying the growth equation to the above data gives

3.2% = (0.3)*(2.6%) + (0.7)*(1.4%) + 𝑔𝐴

= 0.78% + 0.98% + 𝑔𝐴

= 1.76% + 𝑔𝐴
The contribution of productivity thus the residual after subtracting off the contributions from capital
and labor:
𝑔𝐴 = 3.2% - 1.76% = 1.44%

b) Which of the exogenous variables had the largest relative contribution to growth over that
period? (Hint: the relative contribution of capital is (0.3*2.6)/3.2 = 24.4%.)

The relative contributions to growth are

• K: 0.78/3.2 = 24.4%
• N: 0.98/3.2 = 31.0%
• A: 1.44/3.2 = 44.6%

Productivity has the largest average contribution to postwar growth for the United States!

c) Using the same production function above, fill out the following table.
 Sources of Growth of the United States Economy
Years %∆Y (0.3)·% ∆K (0.7)·% ∆N %∆A
1950 -59 4.0 0.4 0.5 3.1
1960-69 4.1 0.9 1.2 2.0
1970-1979 2.9 1.1 1.5 0.3
1980-1989 2.5 0.9 1.3 0.3
1990-1992 0.6 0.6 -0.1 0.1
d) Which variable was responsible for growth slowdown, starting in 70s?

Productivity. The growth rate dropped from 2% in 60s to 0.3% in 70s.

Problem 3. Suppose an economy’s production function is Y= A(K0.5N0.5), where A = 10, K = 9 and labor
varies from 1 to 6 labor units. Suppose output can be sold for $4 a unit. Draw the demand for labor
graph. For the results of your calculations in a)-b) use the following table:

a) How many labor units do profit-maximizing firms hire when each labor unit works an 8-hour
day and the hourly wage is $4? Explain your answer.
 4 labor units. Profit maximizing firm hires up to the point where MRPN=W. W=$32 because each labor
unit works for 8 hours and hourly wage is $4. From the table, MRPN of the fifth worker is less than 32.

b) Suppose the price of the good becomes $5. How many labor units do profit-maximizing firms
will hire now? Explain your answer and show the change on your graph.

6 labor units. We move down from point A to point B along the MPN curve. Increase in price decreases
the real wage, and firm demands more units of labor.

c) How the number of labor units supplied is related to the real wage? Explain why. What shape
has the aggregate labor supply curve? What is the difference of the shape of the aggregate labor
supply curve from the individual labor supply curve? Explain.

One should talk about income and substitution effects of change in wage and state that if SE dominates
IE, then individual labor supply is upward sloping (and vice versa). Aggregate labor supply is the sum of
individual labor supply curves and will be flatter.

W
d) Explain what should happen to the labor supply curve in the ( – N) space when
P
i. there is an increase in the nominal wage, ceteris paribus

Movement along the curve. If substitution effect dominates, labor supply is upward-sloping
and we move up along the curve (work more for higher wage). If income effect dominates, labor
supply is downward-sloping and worker works less for higher wage. Same logic applies to
aggregate supply curve.

ii. there is an increase in the working-age population, ceteris paribus

Aggregate labor supply curve shifts to the right.

iii. there is a sudden decline in the wealth of individuals, ceteris paribus

Aggregate labor supply curve shifts to the right.

iv. government imposes a mandatory retirement age of 65, ceteris paribus.

This decreases labor force participation rate - aggregate labor supply curve shifts to the left.

Problem 4. Calculate and graph the growth rate of total factor productivity since 1960 using FRED
series MFPNFBS. How would you characterize the movements in productivity since 1960? How do
recessions affect the growth rate of productivity? How was productivity affected by the oil shocks of
1973–1975, 1979–1980, 1990, and 2003–2008?
Total factor productivity is generally rising over time. The growth rate of total factor productivity is usually
positive, but sometimes negative around the times of recessions. TFP growth generally declines during oil-price
shocks.

Problem 5. Visit the National Statistics of the UK website: EARN01: Average weekly earnings - Office
for National Statistics (ons.gov.uk) and download the excel file Average weekly earnings. Note that
data is at monthly frequency and going back to 2000. Answer the following questions using the data
from the tab named AWE Total Pay.
a) Plot weekly earnings for the whole economy. Has it ever declined? Why?

It has declined during crises – especially during the Financial crisis of 2008 and the COVID recession.
b) Now plot the following five time series in the same graph: earnings for the whole economy,
private sector, public sector, services and finance sector. Answer the following questions:

i. Which sector experienced consistently higher earnings than others?

Financial sector

ii. What is the percentage difference between that sector and whole economy in January
2007? How about January 2023?

27%; 35%

iii. Calculate the standard deviation of weekly wages in each sector. Use the excel equation
STDEV(). Report the numbers. Which series has the highest standard deviation?
Finance sector has the highest earnings and at the same time most volatile ones.