Chapter 5 Economic Growth Answer Key

1. The Industrial Revolution refers to the widespread use of power-driven machinery and the economic and social changes that resulted in the first half of the 1800s. Ingenious machines—the steam engine, the power loom, and the steam locomotive—performed tasks that would have taken vast numbers of workers to do. The Industrial Revolution began in Great Britain, and soon spread to the United States, Germany, and other countries.

2. Property rights are the rights of individuals and firms to own property and use it as they see fit. Contractual rights are based on property rights and they allow individuals to enter into agreements with others regarding the use of their property providing recourse through the legal system in the event of noncompliance. Economic growth occurs when the standard of living increases in an economy, which occurs when output is increasing and incomes are rising. For this to happen, societies must create a legal environment that gives individuals the ability to use their property to their fullest and highest use, including the right to trade or sell that property. Without a legal system that enforces contracts, people would not be likely to enter into contracts for current or future services because of the risk of non-payment. This would make it difficult to transact business and would slow economic growth.

3. Yes. Since productivity is output per unit of input, we can measure productivity using GDP (output) per worker (input).

4. In 20 years the United States will have an income of 10,000 × (1 + 0.01)²⁰ = $12,201.90, and South Korea will have an income of 10,000 × (1 + 0.04)²⁰ = $21,911.23. South Korea has grown by a multiple of 2.1 and the United States by a multiple of 1.2.

5. Capital deepening and technology are important. What seems to be more important is how they are combined.

6. Government can contribute to economic growth by investing in human capital through the education system, building a strong physical infrastructure for transportation and commerce, increasing investment by lowering capital gains taxes, creating special economic zones that allow for reduced tariffs, and investing in research and development.

7. Public education, low investment taxes, funding for infrastructure projects, special economic zones

8. A good way to think about this is how a runner who has fallen behind in a race feels psychologically and physically as he catches up. Playing catch-up can be more taxing than maintaining one’s position at the head of the pack.

9. No. Capital deepening refers to an increase in the amount of capital per person in an economy. A decrease in investment by firms will actually cause the opposite of capital deepening (since the population will grow over time).

• There is no direct connection between an increase in international trade and capital deepening. One could imagine particular scenarios where trade could lead to capital deepening (for example, if international capital inflows—which are the counterpart to increasing the trade deficit—lead to an increase in physical capital investment), but in general, no.
• Yes. Capital deepening refers to an increase in either physical capital or human capital per person. Continuing education or any time of lifelong learning adds to human capital and thus creates capital deepening.

10. The advantages of backwardness include faster growth rates because of the process of convergence, as well as the ability to adopt new technologies that were developed first in the “leader” countries. While being “backward” is not inherently a good thing, Gerschenkron stressed that there are certain advantages which aid countries trying to “catch up.”

11. Capital deepening, by definition, should lead to diminished returns because you’re investing more and more but using the same methods of production, leading to the marginal productivity declining. This is shown on a production function as a movement along the curve. Improvements in technology should not lead to diminished returns because you are finding new and more efficient ways of using the same amount of capital. This can be illustrated as a shift upward of the production function curve.

12. In high-income economies, diminishing returns to investments in physical and human capital may not apply because many high-income economies have developed economic and political institutions that provide a healthy economic climate for an ongoing stream of technological innovations. Continuous technological innovation can counterbalance diminishing returns to investments in human and physical capital. These two factors have the added effect of making additional technological advances even easier for these countries.
As a result, productivity growth from new advances in technology will not increase at a diminishing rate or otherwise slow down because the new methods of production will be adopted relatively quickly and easily, at very low marginal cost.

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