Answer Key
- Proximate causes of economic growth are factors like physical capital, human capital, and technology that are directly correlated with economic performance. Fundamental causes are the deeper reasons why these proximate causes differ across countries, and can be categorized into luck, geography, institutions, and culture.
- Conditional convergence is the tendency for the income gap between countries to shrink over time, provided that they share similar characteristics. This contrasts with unconditional convergence, which would imply a narrowing gap between all countries regardless of their characteristics, a phenomenon not generally observed in postwar data.
- Uzawa’s theorem states that for an economy to have an asymptotic path with constant growth rates of output, capital, and consumption, all technological progress must be labor-augmenting or Harrod-neutral. This form of progress increases output as if the economy had more labor.
- The Solow Growth Model assumes an exogenous constant saving rate, meaning households save a fixed fraction of their income. This is a simplifying assumption that avoids modeling intertemporal choices, but it is unreasonable as it implies saving decisions are unaffected by factors like expected future tax increases.
- The “golden rule” saving rate, denoted sgold, is the specific saving rate that maximizes the steady-state level of consumption per capita. When an economy’s saving rate is above the golden rule level, it is considered dynamically inefficient because steady-state consumption could be increased by saving less.
- The First Welfare Theorem states that a competitive equilibrium is Pareto optimal, meaning no one can be made better off without making someone else worse off. It may fail in overlapping generations models because of the “problem of infinity,” where an infinite number of households and commodities can lead to pecuniary externalities that are not second-order, potentially resulting in Pareto suboptimal competitive equilibria.
- Dynamic inefficiency describes a state in an overlapping generations model where the economy is overaccumulating capital, characterized by a steady-state interest rate that is less than the rate of population growth (r* < n). In such a situation, it is possible to reduce the capital stock and increase the consumption of all generations, meaning the competitive equilibrium is not Pareto optimal.
- Creative destruction is the process where new firms, through innovation, improve upon and ultimately destroy incumbent firms and their economic rents. This process is considered the essence of capitalist economic growth in Schumpeterian models, as it requires a level playing field for new entrants to challenge established firms with better technologies.
- In models of directed technological change, the price effect creates stronger incentives to develop technologies for goods that command higher prices, typically those using scarce factors. The market size effect creates incentives to develop technologies for larger markets, typically those using more abundant factors.
- A major shortcoming of the baseline AK model is that the share of national income accruing to capital approaches 1, which is counterfactual. This can be addressed by including both physical and human capital, creating a two-factor model where the share of capital in national income remains constant and at a more realistic level.