Question

1. The economy of Asgard has a well developed financial system, where resources flow to the capital investments with the highest marginal product. The economy of Titan has a less developed financial system that excludes some would be investors.

A. Which nation would you expect to have a higher level of total factor productivity? Explain.

B. Suppose the two economies have the same saving rate, depreciation rate, and rate of technological progress. According to the Solow growth model, how does output per worker, capital worker, and the capital output ratio compare in the two economies?

C. Assume the production function is Cobb-Douglass. Compare the real wage and the real rental price of capital in the two countries.

D. Who benefits from having a better developed financial system?

2. Explain succinctly how the decline in housing price level led to a major financial crisis in 2008-9 in U.S.

Answer 1

Ques 1

Ans.

1

Solow growth model is the framework used to determine the underlying sources of growth for an economy. The model shows that the economy’s productive capacity and potential GDP increase for two reasons:

- accumulation of such inputs as capital, labor, and raw materials used in production, and

- discovery and application of new technologies that make the inputs in the production process more productive

So capital availability is key factor in the growth of the economy.

A. Asgard would have a higher level of total factor productivity because of capital being available.

B. Output per worker, capital worker, and the capital output ratio will be higher in Asgard then Titan

C. The real wage will be higher in Asgard then Titan and the real rental price of capital will be less in Asgard then in Titan. Titan will have high rental price of capital due to less availability of capital.

D. All factors of production and economy as whole benefit from having a better developed financial system.