Chapter 11: Economic Growth
Wealthy nations tend to have much lower rates of ________ and much higher rates of ________ compared to poor nations.
a) adult literacy; infant mortality
b) infant mortality; adult literacy
c) life expectancy; secondary enrollment
d) mobile cellular subscriptions; electricity access
b) infant mortality; adult literacy
World Bank data shows wealthy nations have lower infant mortality and higher adult literacy rates.
Which of the following is the best example of physical capital?
a) A college degree
b) A factory
c) A skilled worker
d) Political stability
b) A factory
Physical capital refers to man-made tools and equipment used in production. A factory is a classic example.
The aggregate demand (AD) curve slopes downward because a lower price level:
a) Increases real wealth, interest rates rise, and exports fall
b) Increases real wealth, interest rates fall, and exports rise
c) Decreases real wealth, interest rates rise, and exports fall
d) Has no effect on real wealth or exports
b) Increases real wealth, interest rates fall, and exports rise
The three effects (wealth, interest rate, international trade) all cause quantity of AD to rise when the price level falls.
The Great Recession lasted from:
a) August 1929 to March 1933
b) December 2007 to June 2009
c) March 2001 to November 2001
d) February 2020 to April 2020
b) December 2007 to June 2009
The Great Recession officially ran from December 2007 to June 2009, as identified by the NBER.
Which of the following best explains why nominal GDP growth is a poor measure of actual economic growth?
a) It excludes government spending
b) It does not adjust for changes in prices or population growth
c) It counts only manufacturing output
d) It ignores investment spending
b) It does not adjust for changes in prices or population growth
Nominal GDP can grow simply because prices rose or because there are more people — not because each person is better off.
If nominal GDP grew by 6%, prices increased by 2%, and population grew by 1%, what is the approximate real per capita GDP growth rate?
a) 3%
b) 4%
c) 5%
d) 7%
a) 3%
Real per capita GDP growth ≈ %Δ Nominal GDP − %Δ prices − %Δ population = 6% − 2% − 1% = 3%.
According to the Solow growth model, diminishing marginal product means that as physical capital increases:
a) Output rises at an increasing rate
b) Output rises at a decreasing rate
c) Output falls immediately
d) The production function shifts upward
b) Output rises at a decreasing rate
Diminishing returns mean each additional unit of capital adds less to output than the previous one.
Which of the following would cause a rightward shift of the aggregate demand curve?
a) A decline in consumer confidence
b) An increase in income taxes
c) A surge in stock market values
d) A decrease in government spending
c) A surge in stock market values
Higher stock values increase household wealth, boosting consumption and shifting AD right.
Keynesian economists believe prices are ________ and focus primarily on the ________ run.
a) flexible; long
b) flexible; short
c) sticky; long
d) sticky; short
d) sticky; short
Keynesians argue that sticky prices prevent rapid self-correction, making short-run intervention necessary.
In the Solow model, a country reaches its 'steady state' when investment equals depreciation. What happens to a country's capital stock and output AFTER it reaches this steady state, assuming no technological change?
a) Both continue to grow exponentially
b) Capital grows but output stays constant
c) Both stop growing; the country stays at the same income level
d) Capital falls and output grows
c) Both stop growing; the country stays at the same income level
At steady state, investment just replaces worn-out capital, so no net capital accumulation occurs and output stabilizes.
Using the rule of 70, if a country's real per capita GDP grows at 3.5% per year, approximately how many years will it take for income to double?
a) 10 years
b) 14 years
c) 20 years
d) 35 years
c) 20 years
Rule of 70: 70 / 3.5 = 20 years.
In the Solow model, if the level of capital is 2,000 units, the depreciation rate is 10%, and investment is 150 units, what happens to the capital stock?
a) It increases, because investment exceeds depreciation
b) It decreases, because depreciation (200) exceeds investment (150)
c) It stays the same — this is a steady state
d) It decreases only if the workforce also shrinks
b) It decreases, because depreciation (200) exceeds investment (150)
Depreciation = 10% × 2,000 = 200. Investment = 150. Net investment = 150 − 200 = −50, so capital falls
Starting from long-run equilibrium, if oil prices rise sharply, which of the following best describes the short-run and long-run effects?
a) SR: SRAS shifts left, price rises, output falls. LR: wages fall, SRAS shifts right back to equilibrium.
b) SR: AD shifts left, price falls, output falls. LR: wages rise, SRAS shifts left.
c) SR: LRAS shifts left permanently. LR: no adjustment occurs.
d) SR: AD shifts right, price rises. LR: SRAS adjusts right.
a) SR: SRAS shifts left, price rises, output falls. LR: wages fall, SRAS shifts right back to equilibrium.
Supply shocks shift SRAS. In the long run, flexible input prices allow SRAS to self-correct back to full employment.
During the Great Recession, which of the following caused both a leftward shift in aggregate demand AND a leftward shift in long-run aggregate supply?
a) A fall in oil prices and increased consumer spending
b) A stock market decline reducing wealth (AD) and institutional breakdown in financial markets reducing investment (LRAS)
c) A government tax increase and a population decline
d) A rise in inflation expectations and a surge in technology
b) A stock market decline reducing wealth (AD) and institutional breakdown in financial markets reducing investment (LRAS)
Falling stock prices hurt household wealth (shifting AD left), while the financial market breakdown impaired the loanable funds market, reducing productive capacity (shifting LRAS left).
If Mexico, a U.S. trading partner, experiences an increase in wealth, what would we expect to happen to U.S. aggregate demand in the short run?
a) U.S. AD would shift left as Mexican imports fall
b) U.S. AD would shift right as Mexican demand for U.S. exports increases
c) U.S. AD would be unaffected since Mexico is a separate economy
d) U.S. LRAS would increase due to increased trade volumes
b) U.S. AD would shift right as Mexican demand for U.S. exports increases
Wealthier Mexicans buy more goods, including U.S. exports. Higher U.S. net exports raise U.S. aggregate demand.
Country A has nominal GDP growth of 12%, inflation of 10%, and population growth of 1.5%.
Country B has nominal GDP growth of 5%, inflation of 2%, and population growth of 1%.
Both start with real GDP of $1,000 per citizen. Calculate the economic growth rate for each country and determine real GDP per capita for each after 140 years.
Country A: 0.5%; Country B: 2%
Worked out:
A: 12−10−1.5 = 0.5%, doubles in 140 yrs → $2,000
B: 5−2−1 = 2%, doubles every 35 yrs → doubles 4 times in 140 yrs → $1,000 × 16 = $16,000
Explain why the Solow growth model predicts convergence — that poor countries should 'catch up' to rich countries. Then explain why this convergence does not always occur in practice, using the concept of institutions from modern growth theory.
Solow: diminishing returns mean poorer countries have higher marginal returns to capital, attracting more investment. Modern theory: without growth-friendly institutions, investment does not flow and convergence fails.
Rich countries are closer to steady state and grow slowly. Poor countries, theoretically, grow faster. But without rule of law, property rights, etc., investment is discouraged and convergence stalls
Using an AD-AS diagram, explain and illustrate the short-run and long-run effects of an increase in government spending starting from long-run equilibrium. What happens to the price level and output in each run?
SR: AD shifts right → output above full-employment, price level rises. LR: wages rise, SRAS shifts left → price level rises further, output returns to full-employment level.
In the short run, higher G raises output and prices. Over time, workers negotiate higher wages, SRAS contracts, and output returns to Y* but at a permanently higher price level.
From a Keynesian perspective, explain why an economy can become 'stuck' in a recession without government intervention. What policy tool did Keynes recommend during the Great Depression, and why?
Sticky prices prevent wages from falling fast enough to restore full employment. Keynes advocated expansionary fiscal policy (government spending on infrastructure/social programs) to boost aggregate demand.
With sticky prices, a leftward AD shift keeps output below Y* indefinitely. Government spending directly increases AD, shifting it right and pulling the economy back toward full employment
During the COVID-19 recession, several factors simultaneously shifted the AD curve to the left.
Identify THREE specific factors that caused this shift and explain the mechanism by which each reduced aggregate demand.
1) Falling incomes → less consumption. 2) Declining real wealth (stocks, home values) → reduced spending. 3) Lower business confidence → reduced investment. Bonus) Declining foreign incomes → lower U.S. exports.
All four factors reduce components of AD (C, I, or NX), shifting the curve left and reducing equilibrium output.
Explain how institutions such as private property rights, rule of law, and stable money and prices each independently contribute to long-run economic growth. Use examples to support your reasoning.
Strong institutions create incentives to invest, reduce corruption, ensure contract reliability, and encourage long-term economic activity.
Private property rights reward investment; rule of law ensures contracts are honored; stable money reduces uncertainty for investors. Without these, capital accumulation is inefficient.
Modern growth theory diverges from the Solow model in its treatment of technology and institutions. Compare and contrast the two theories, explaining how each accounts for sustained long- run growth and why countries might have persistently different income levels.
Solow: exogenous technology, diminishing returns lead to steady state. Modern theory: endogenous technology, institutions explain why countries diverge persistently.
Solow predicts convergence but cannot explain persistent divergence. Modern growth theory explains divergence through different institutions — countries with better institutions grow faster indefinitely.
Compare and contrast the slopes and economic significance of the LRAS and SRAS curves.
Why are input prices 'sticky' in the short run, and what implications does this have for how the economy responds to a demand shock? Include a discussion of how the economy self-corrects without policy intervention.
LRAS is vertical (output fixed at full-employment). SRAS slopes upward due to sticky wages/input prices. In SR, demand shocks cause output to deviate from Y*. LR self-correction occurs as wages adjust.
Wage contracts, menu costs, and information lags make prices sticky. When AD rises, firms expand output short-term. Eventually wages rise, SRAS shifts left, restoring full employment at a higher price level.
Compare classical and Keynesian macroeconomic perspectives across four dimensions: (1) price flexibility, (2) role of aggregate demand vs. supply, (3) the need for government intervention, and (4) their policy prescriptions during a recession. Which view better explains the Great Recession and why?
Classical: flexible prices, supply-side focus, no intervention needed, let markets self-correct. Keynesian: sticky prices, demand-side focus, government should stimulate during recessions. The Great Recession better supports Keynesian view given prolonged unemployment and slow self-correction.
The Great Recession saw unemployment remain elevated for years despite classical predictions of quick recovery. This supports sticky prices and the need for fiscal stimulus, consistent with Keynesian reasoning.
Imagine a developing country with weak property rights, low physical and human capital, and a persistent recession caused by a collapse in consumer confidence.
Using concepts from Chapters 11– 14, construct a comprehensive policy proposal. Address: (a) what long-run growth strategies are needed, (b) how the AD-AS framework diagnoses the recession, and (c) whether a classical or Keynesian approach better fits this situation and why.
(a) Strengthen institutions (property rights, rule of law), invest in education/physical capital, encourage foreign investment. (b) AD has shifted left → output below full employment. (c) Keynesian: sticky prices in developing economies mean self-correction is slow; fiscal stimulus + structural reform needed.
This question integrates Ch11 (institutions, growth), Ch12 (Solow & modern growth theory), Ch13 (AD-AS model), and Ch14 (Keynesian vs classical debate) into one policy scenario.