Question

1. Consider the economy of country A. The nominal GDP increases from $40,000 to $80,000 in 15 years. Annual population growth rate is 2% and the annual inflation rate is 1%.  

1. Calculate the annual economic growth rate of country A.
2. Approximately, how long will it take for the real GDP per capita of country A to double?
3. The country discovered a new oil field, but economic growth rate fell afterward. Explain how this could happen.
4. For each of the following separate policies, determine the associated factor of economic growth.

(1) natural resources; (2) physical capital; (3) human capital; (4) technology; or (5) institutions:

(Explanations are not required, choose only one from the above list for each of the following)

1. The government allows for the freedom of speech.
2. Small companies receive tax credit from the government for hiring high-school dropouts.
3. Firms are penalized for burning coal as a source of energy.
4. The country plans to expand the subway system.
5. The government hires more police to improve the law and order.

Answer 1

i) Let Growth rate of Nominal GDP be x

So 80000 = 40000 * (1+x/100)^15

or 1+x/100 = 1.0473

or x = 4.73%

So the nominal economic growth rate is 4.73%

ii) Let the real GDP per capita double in t years

Nominal GDP Growth in t years = G * (1+4.73/100)^t where G = initial GDP

GDP Inflator at 1% inflation = 1.01

So Real GDP after t years = Nominal GDP / 1.01 = G / 1.01 * 1.0473^t

Population Growth in t years = P * (1+2/100)^t = p*1.02^t where P = initial ppopulation

Real GDP per capita currently = G/P

Real GDP Per capita after t years = (G / 1.01 * 1.0473^t) / (P * 1.02^t ) = G/P * (1.0473/1.02)^t * 1/1.01 = G/P * 1.0267^t * 1/1.01

Now, as per conditions,

G/P * 1.0267^t * 1/1.01 = 2* G/P

or 1.0267^t * 1/1.01 = 2

or 1.0267^t = 2.02

or t log 1.0267 = log 2.02

or t = 26.68 ~27

So the GDP per capita will double in approximately 27 years.

iii) With the discovery of an oil field, oil supplies can go up very fast. This will lead to a very rapid drop in oil prices and thus as a domino effect, prices of everything will start going down. GDP, which is a product of the quantity and price of a basket of goods, also goes down in spite of rising quantity. Thus economic growth can slow down in case of discovery of a new oil field if the prices are not regulated.

iv)

1) natural resources; Firms are penalized for burning coal as a source of energy.

(2) physical capital;The government hires more police to improve the law and order.

(3) human capital;The government allows for the freedom of speech.

(4) technology;The country plans to expand the subway system.

(5) institutions:Small companies receive tax credit from the government for hiring high-school dropouts.

If you found this helpful, please rate it so that I can have higher earnings at no extra cost to you. This will motivate me to write more.