Macroeconomics and Economic Policy

Gregory de Walque

Chapter 12: exercises

12.1 .
(a) The statement is not true. First, there has been a decline in technological progress during the years 70 to 85 but since then technological progress has again risen. Furthermore, even though there
is a clear link between R&D spending and technological progress,
there can be a delay before the R&D spending indeed translate
into technological progress. Actually technological progress can
also result from a new way to organize activities within and between rms, with rms specializing on their core business and
outsourcing all the other activities.
(b) True. Remember from the capital accumulation equation adapted
for taking population growth and technological progress into account, that gA (growth rate of technological progress) acts as
a "negative force" for the accumulation of capital per e cient
worker. If one of the three "negative forces" increases, the saving
rate has to be increased in order to keep the same capital stock
per e cient labour unit:
(1+gA )(1+gN )

Kt
At Nt

Kt+1
At+1 Nt+1

=sF

Kt
At Nt

( + gA + gN )

If you want to see it "graphically", an increase in gA means that

the line of slope + gA + gN becomes more sloppy. If s remains
K
unchanged it will cross the s F AN
curve at the left of the initial
K
intersection, determining a lower steady state AN
. In order to keep
K
K
unchanged,
it
is
thus
required
to
shift
up
the
s F AN
curve,
AN
which can be done by increasing the saving rate s.
(c) False. At the steady state, which is actually now a steady growth
path, output per worker grows at the same rate as technological
progress, i.e. gA which is dierent from the population growth
rate gN . Output per e cient worker grows at rate zero and output
grows at the rate gN + gA .
(d) True. See answer in (c) above.
1

Kt
At Nt

Y
(e) True. Indeed, if AN
= x and that A becomes A0 = A(1 + 0:05)
while Y remains unchanged, the only possibility is that N shifts
to N 0 = (1 0:05) such that

Y
AN

= x=
'

Y
A0 N 0

A(1 + 0:05) N (1 0:05)

1
Y
Y
'
=
AN (1 0:005)
AN

(f) True, since it will not be possible for the private rm to get a
nancial return out of this theorem. But it is not the only reason.
Actually basic research is at the source of many applied innovations, but the transformation from one step to the other can take
a very long time, and it is always di cult to know in advance
which outcome of fundamental research will be helpful in the end,
and which will not. Time and uncertainty about the possibility to
transform fundamental research into useful and marketable technological innovations make that private rms do not enter this
path.
(g) True. As in chapter 11, the long run growth rate of output is
independent of the saving rate. Actually, the long run growth rate
of output is gY = gA + gN showing that it only depend of the
growth rate of population and of the growth rate of technology.
(h) The question is actually badly stated. If indeed the potential returns of investing in R&D are equal to those of investing in K,
then it should be the case that both investment face the same
level of risk. Actually, investing in R&D is much more risky than
investing in K since when you invest in K, you already know what
the new machine will help you to produce and sell. When investing
in R&D, you are never sure of the outcome of the research. It can
be nothing or it can be the jackpot.
12.2 .
(a) For the advanced economies (or old industrialized countries) the
main source of technological progress is innovation, that comes
from the R&D process. Since they already implemented the "old"
technologies, the only way to continue to make output per worker
grow is to continue to create "new" technologies. Less advanced
2

countries can benet from technological progress created in the

more advanced economies, by importing capital goods endowed
with the technologies that have been developed elsewhere. This
has been for example the development strategy of Japan at the
beginning of the XXth century. However, since then Japan has
joined the club of economic leaders and relies on R&D to develop
new technologies that will help maintain its growth rate of output
per worker.
(b) Developing countries may have an interest in having a loose patent
protection. Indeed, the protection of patents favour more the developed countries who produce these patents. By not endorsing
the patent protection legislation, developing countries somehow
authorizes their economic actors to use technological innovations
developed by others without having to pay for it. The danger then
is that they can only sell the goods produced thanks to this protected innovation in their own market. If they try to export these
goods, they will be suited by the owner of the patents.
12.3 .
(a) Spending in R&D is the only way to reach technological progress
which is actually the only possibility to ensure the growth of income per capita. In the absence of investment in research and development (through private and public funds) the economy would
go back to a period of great stagnation. The appropriability of
research is an important and essential incentive for rms to make
research. In the absence of the possibility for the private sector
to be rewarded for its research eorts, they would not enter this
way. One of the best known way for research to be rewarded is
through the system of patents, in which the owner of a patent
has got a monopoly on the patented innovation for a given period
of time. Such patents can of course be sold to other rms but
in this case the seller lose the right to use the innovation. The
fertility of research is one of the most important things observed
since the industrial revolution. The largest and the most connected
the community of researchers, the more innovations cross-fertilize
across domains that can appear a priori very dierent. For example, innovations in physics and chemicals are key for the computer
science.
(b) Such an international treaty would of course favour appropriability, as the outcome of research would then be protected all over
3

the world through a unied system of patents. As it would give

more incentive for private rms to develop research programs, and
this all over the world (i.e. even in developing and emerging
economies), increase potentially the number of researchers and
the possibilities of cross-fertilization of ideas, leading towards new
development and new processes.
(c) A tax credit for each $ spent in R&D will have no eect for the
appropriability of research. It is not because research is partially
subsidized that the outcome of research will be better protected.
This is pretty dierent. On the other hand, the scal incentive
to invest in R&D can help make grow the size and numbers of
research programs, which can only be good for fertility.
(d) A decrease in subsidies nancing conferences between universities
and corporations: will have no eect on the possibilities of appropriation of the benets of research by the rms, but will aect the
possibilities of fertility as it reduces one channel of communication
between researchers in academia and in the private sector.
(e) The elimination of patents on breakthrough drugs in order to sell
them at low cost: this clearly destroy the possibilities for rms to
obtain benets out of their research. Their incentive for research
will denitely be reduced. This reduction in research activities by
the rms will also aect fertility: less volume of research reduces
the possibilities of cross-fertilization.
12.4 .
(a) a permanent reduction in the growth rate of technological progress
from gA to gA0 < gA will
- lead to a progressive increase in the level of output per e cient
labor unit through a higher capital accumulation per e cient
labour unit. Therefore, in the rst years after the decrease in
gA it is possible that output increases more than its initial
growth rate gA + gN : However, this is only very temporary.
- when the output per e cient worker has stabilized to its new
equilibrium level, the long run growth rate of the economy is
gA0 +gN < gA +gN . Because of this, the output level in coming
decades will be lower than it would have been if technological
progress had continued to grow at the same rate gA .
(b) a permanent reduction in the saving rate from s to s0 < s will
4

- lead to a progressive decrease in the level of output per efcient labour unit through a lower capital accumulation per
e cient labour unit. In the rst years after the shift from s
to s0 , the GDP will grow at a pace lower than the long run
equilibrium growth rate (equal to gA + gN ):
- but after some decades, the economy will converge to a new
steady state characterized by a permanently lower GDP per
e cient labour unit. When the economy has reached this new
steady state, the GDP grows at the same pace as initially, i.e.
gY = gA + gN .
12.5 .
(a) The nominal GDP in each year is respectively equal to
GDP1nom = (P1h Qh1 ) + (P1b
= (10 100) + (10
= 3000

Qb1 )
200)

GDP2nom = (P2h Qh2 ) + (P2b

= (12 100) + (12
= 3960

Qb2 )
230)

(b) Using the prices of year 1, the real GDP of years 1 and 2 are
respectively
GDP1real = (P1h Qh1 ) + (P1b
= (10 100) + (10
= 3000

Qb1 )
200)

GDP2real = (P1h Qh2 ) + (P1b

= (10 100) + (10
= 3300

Qb2 )
230)

and the growth rate of real GDP is

3300 3000
GDP2real GDP1real
=
= 10%
3000
GDP1real
5

(c) The GDP deator can be computed as

GDP1nom
GDP1real
and

GDP2nom
GDP2real

100 = 100

100 =

3960
3300

100 = 120

From these values we can compute the ination rate as

=

P2

P1
P1

120 100
= 20%
100

(d) Using year 1 prices, the real GDP per worker can be computed as
GDP1real
3000
3000
=
= 30
=
h
b
W1
100
(W1 + W1 )
GDP2real
3300
3300
=
=
= 30
h
b
W2
110
(W2 + W2 )
As the real GDP per worker is unchanged between year 1 and
2, it is the case that labour productivity is unchanged as well
(since labour productivity is nothing else than real GDP divided
by labour units). Therefore labour productivity growth is zero.
The increase in real GDP is coming from the increase in the number of workers.
(e) The table becomes
year 1
P1 Q1
Haircut
10 100
Banking
10 200
Telebanking 13 0

W1
50
50
0

year 2
P2 Q2
12 100
10 0
12 230

W2
50
0
60

and you can easily check that, using year 1 prices, the real GDP
for year 2 is now computed as
GDP2real = (P1h Qh2 ) + (P1b
= (10 100) + (10
= 3990

Qb2 ) + (P1tb Qtb

2)
0) + (13 230)

The growth rate of real GDP can now be re-computed as

3990 3000
GDP2real GDP1real
=
= 33%
real
3000
GDP1
which is signicantly higher than the 10% growth rate computed
higher.
(f) The rate of ination deserves to be re-computed on this new basis.
The GDP deator can be computed as
GDP1nom
GDP1real

100 = 100

and

GDP2nom
3960
100 =
100 = 99:25
real
3990
GDP2
From these deator values we can compute the ination rate as
=

P2

P1
P1

99:25 100
=
100

0:75%

(g) Labour productivity has now increased compared to what had

been computed in (d) above. Indeed, labour productivity is equal
to real GDP per worker and we compute that
3000
GDP1real
3000
=
=
= 30
h
b
tb
W1
100
(W1 + W1 + W1 )
3990
3990
GDP2real
= 36:273
=
=
W2
110
(W2h + W2b + W2tb )
and labour productivity has now grown by
36:273 30
= 21%
30
(h) If we do not take into account the introduction of the telebanking
services, we will indeed overestimate ination as we will consider
that banking services prices increase from 10 to 12, while actually
it should be considered that telebanking prices shrinks from 13 to
12. It also yields a bad assessment of real GDP since telebanking services are priced the same way as banking services, while
actually, telebanking services are more expensive than banking
services. All this is pretty clear when comparing (b) with (e), (c)
with (f) and (d) with (g).
7

12.6 .
(a) geographic location should, according to the Solow model, have no
role on the steady state of output. However, we will all agree that
labour is easier under some climate conditions than others. In general temperate climates are assumed better suited for production
than too hot or too cold ones.
(b) education is important rst for the human capital, determining the
e ciency of workers. Furthermore, a higher level of education will
induce better research and more technological innovation. This
will thus also have an impact on the level of technology.
(c) Protection of property rights in general give investors an incentive
to invest. Therefore it will aect positively the capital stock. If this
protection extents to ideas and the outcome of research, it will also
give an incentive for research and aect the level of technology as
well.
(d) A priori, according to the Solow model (which is a closed economy model) openness to trade should aect none of the three
dimensions A, K, or H. However, if it is possible to exchange
goods with other countries, it is possible to by investment goods
endowed with particular technologies that have been developed
in foreign countries. This is a very powerful way to introduce new
technologies in the country without having to pay the full research
and development costs required for it.
(e) Low tax rates have no eect on any of the three dimensions A, K,
or H.
(f) Good public infrastructure gives rms an incentive to invest, since
the public infrastructure is present and helps to carry the produced
goods from the place where they are produced to the place where
they are consumed.
(g) A low population growth facilitates the acquisition of capital per
capita (the slope of the + gN + gA line is less steep and so that
Y
curve further to the right, which corresponds
it crosses the s N
to a higher GDP per e cient worker and therefore a higher GDP
per worker). Therefore it will help to reach a higher level of GDP
per capita.
12.7 Consider the following production function
p p
Y = K AN
8

with the parametrization of the economy

s =
=
gN =
gA =

16%
10%
2%
4%

(a) .
i. We may compute the steady state capital stock per e cient
labour unit as follows
p
K
K
0 = s p
( + gN + gA )
AN
AN
p
K
K
, s p
= ( + gN + gA )
AN
AN
p
s
K
,
=p
+ gN + gA
AN
2
K
s
,
=
AN
+ gN + gA
0:16
K
=
AN
0:10 + 0:02 + 0:04
K
=1
,
AN

ii. From there the output per e cient labour unit can be computed as follows
p
K
Y
= p
AN
AN
r
K
=
p AN
=
1
= 1
Y
iii. The long run equilibrium growth rate of AN
is zero...
Y
iv. ... while N in the long run equilibrium grows at a rate of
gA = 4%:::
v. ... and output grows at gA + gN = 6%.

(b) If gA doubles from 4% to 8% the answers computed in (a) become

i.
K
AN

+ gN + gA

K
0:16
,
=
AN
0:10 + 0:02 + 0:08
K
,
= 0:64
AN

ii.
p
K
= p
AN
r
K
=
p AN
=
0:64 = 0:08

Y
AN

Y
iii. The long run equilibrium growth rate of AN
is unchanged to
zero...
Y
in the long run equilibrium grows at a rate of
iv. ... while N
gA = 8%:::
v. ... and output grows at gA + gN = 10%.

(c) If gA = 4% and gN = 6% then the answers computed in (a) become

i.
K
AN

+ gN + gA

0:16
K
=
,
AN
0:10 + 0:06 + 0:04
K
,
= 0:64
AN

which is identical to what we computed in (b).

ii.

r
p
p
Y
K
K
=
=p
= 0:64 = 0:08
AN
AN
AN
which is also identical.
Y
iii. The long run equilibrium growth rate of AN
is unchanged to
zero...
10

Y
iv. ... while N
in the long run equilibrium grows at a rate of
gA = 4%:::
v. ... and output grows at gA + gN = 10%.

Even though the answers look very similar to those computed

in (b), people are more happy in the economy (b) than in (c).
Y
) grows more
The reason is that their individual income (i.e. N
rapidly. What is important for people welfare is income per worker
rather than global income (i.e. GDP). It is therefore better that
the economy grows because of technological progress rather than
because of population growth.
12.8 Given the production function
1=3

Yt = Kt (At Nt )2=3
we can deduce that
2
2
1
ln(Kt ) + ln(At ) + ln(Nt )
3
3
3
and equivalently
1
2
2
ln(Yt 1 ) =
ln(Kt 1 ) + ln(At 1 ) + ln(Nt 1 )
3
3
3
ln(Yt ) =

and removing the second equation from the rst one, we obtain an
equation in growth rate
ln(Yt )

1
2
2
1
2
2
ln(Kt ) + ln(At ) + ln(Nt )
ln(Kt 1 )
ln(At 1 )
ln(Nt 1
3
3
3
3
3
3
1
2
2
=
[ln(Kt ) ln(Kt 1 )] + [ln(At ) ln(At 1 )] + [ln(Nt ) ln(Nt 1 )]
3
3
3

ln(Yt 1 ) =

We remember also that

gX =

Xt

Xt
Xt

' ln

Xt
Xt 1

= ln(Xt )

ln(Xt 1 )

which says that the rst dierence of a series in logarithm is a fairly

good approximation of the growth rate of this series (as long as the
growth rate is not too large). Therefore, we obtain
gY

1
2
2
gK + gA + gN
3
3
3
1
, (gY gN ) = (gK
3
=

2
gN ) + gA
3

which is well the relationship stated in the exercise.

11

(a) The quantity gY

gN represents the growth rate of output per
worker while gK gN represents the growth rate of capital per
worker. Therefore the expression
(gY

gN ) =

1
(gK
3

2
gN ) + gA
3

says that the growth rate of output per worker comes for one third
from the accumulation of capital per worker (i.e. the growth rate
of capital per worker), and for two third from the growth rate of
technological progress. Note also that
(gY

1
(gK
3
1
=
(gK
3

gN ) =

2
gN ) + gA
3
gN

gA ) + gA

According to the Solow model, in the long run equilibrium the

growth rate of capital per e cient worker is zero (i.e. gK gN
gA = 0), such that the growth rate of income per capita (i.e. gY
gN ) is simply equal to the growth rate of technological progress
(i.e. gA ).
(b) Or equivalently, the growth rate of capital per worker can be computed as
(gK gN ) = 3 (gY gN ) 2 gA
(c) Using the gures in Table 12-2, we may compute a crude measure
of the growth rate of capital per worker (i.e. gK gN ) as being
- for France:
(gK

gN ) = 3 (gY
= 3 3:2
= 3:4%

gN ) 2 gA
2 3:1

- for Japan:
(gK

gN ) = 3 4:2
= 5%

2 3:8

(gK

gN ) = 3 2:4
= 2:0%

2 2:6

- for UK:

12

- for US:
(gK

gN ) = 3 1:8
= 1:4%

2 2:0

(gK

gN ) = 3 2:9
= 2:9%

2 2:9

- average:

13