Question

Question 5

a) Let’s assume that the total investment (% of GDP) and saving rates are the same for two hypothetical countries in Asia. Aruba had a 4% growth rate of average annual income per capita and Smalland had a 1% growth rate. Based on the economic concept/s you have learned, explain what would have caused the growth rates to be different? Diagram/s are required.                                                                                                                            

b) Due to high levels of inflation, the Central Bank in Country A decides to sell government bonds. Using the Phillips curve framework, explain and analyse how this will impact unemployment in the short run and long run. Diagram/s are required.

                                                                                                                                   

Answer 1

( a ) According to the neoclassical growth theory, there are four determinants of economic growth:-

Savings rate, investment, labor, and knowledge or technology.

As both the countries had same level of total investment, and saving rate, and quantity of labor, the only other factor that would have contributed to higher growth rate in annual income per capita in Aruba would be knowledge or an improvement in technology or productivity.

( b ) As the Central Bank in Country A decides to sell government bond, money supply in the economy will decrease, which in turn will lead to a decrease in general price level or inflation rate in the economy.

However, as we know according to Phillips curve, there is a trade off between short - term unemployment rate and inflation rate. As inflation decreases, it would lead to higher unemployment in the economy in the short - run.

However, in the long - run employment will reach back to the equilibrium level again as shown in the diagram.