Question

Exercise 1. Consider two economies in which the population is stable; they are identical in every respect except that households in economy A save more of their income than households in economy B. How will these economies differ in terms of the level of output, labour productivity, and the growth rates of output and productivity? Explain.

Now consider countries C and D, both identical except that firms in country C allocate more resources to research and development (which tends to lead to improvements in production) than those in country D. How will these countries differ in terms of the same variables above?

2. Total income of residents (Yp) is equal to gross income (Y) minus taxes (T) plus net income from international transfers (R). Private sector total savings is S = Yp – C. The domestic absorption of total expenditure is private sector consumption (C) plus investment (I) plus government expenditure (G), and foreign demand equals net export (i.e. export X minus import Z). Based on these identities answer the following:

a) The current account of the balance of payments (defined as X–Z±R) is equal to what? To find it out, you have to derive an equation between the foreign sector and domestic net absorption, show all the steps!

b) If the current account value is minus five percent of GDP and the government budget is in deficit of 2% (of GDP), then which of the following is true: I=S or S<I or S>I? Explain why so.

c) If the private sector net savings equal to 1% and the government budget deficit in 2% (relative to GDP both), then which of the following is true: X=Z or X<Z or X>Z? Explain why.

3. Data analysis – annual national accounts (based on Eurostat data):

a) Find out the gross domestic product, private consumption and investment annual figures for Finland and one important trading partner country (upon your own choice) over the past 15 years in both nominal and real terms. Show all the variables in one table.

b) Compute the growth rates of each variable and plot the data on graphs. Describe briefly the dynamics of the variables and try to identify signs of a business cycle.

c) Analyse the time series and figure out whether there were periods of faster / slower growth (than average) and provide some explanation why those deviations did occur.

Answer 1

1.

Higher savings lead to higher investment in the country. It leads to capital formation, which results in higher level of output due to more capital. Availability of more savings offers a chance for investment in physical as well as human capital.it also increases labor productivity due to up gradation in manpower and machinery, technologies. Therefore the level of output and labor productivity of A shall be higher than that of B. since more resources are invested in the human and physical capital in A the growth rates of output and productivity shall also be higher than B due to skilled labor and advanced technology.

Research and development is the major factor for competitive market and innovation. It is an integral part of innovation process. Hence, allocation of more resources to R&D will increase quantity and quality of production thereby causing an increase in national income and trade of the economy.