Mark Taber, CFA, is the Chief Investment Officer of the Taber Emerging Markets Fund, (TEMF). Taber uses a top-down approach to investing in countries. By interviewing government officials and the managements of foreign companies, Taber often gains economic and investment insights not yet fully understood by the foreign market. Taber is currently researching a potential investment in the emerging market country of Alphia. Taber travels to Ullom, the capital of Alphia, to discuss past, present, and future economic growth theory development with Dr. Raman Satish, managing director of the Alphia Economic Development Agency (AEDA).Dr. Satish starts the conversation with Taber by discussing the three great growth cycles that the Alphian economy has experienced over the past 120 years: (1) the classical growth era, (2) the neoclassical growth era, and (3) the new growth era. Taber takes down the following statements from the meeting with Dr. Satish's meeting.1. The Classical Growth Era of Alphia (1850-1950)This hundred-year era was noted for periodic high levels of population growth and the sporadic introductions of technology. The average Alphianian's income was very modest and the standard of living remained almost the same over the 100-year period, except when new technology was introduced. Dr. Satish cites the example of the one-time introduction of electricity to the Alphian economy from 1947 to 1950. E2. The Neoclassical Growth Era o/Alphia (1951-1990)During the neoclassical growth period, Alphia experienced a period of great economic growth. For example, from 1986 to 1990, Alphia's capital per hour of labor grew at a 9% annual rate, while real GDP grew at 7% per annum.Also, Alphia was able to achieve economic growth rates and income levels comparable with many of its neighboring countries during the neoclassical growth period. Alphian scientists, together with the engineering department of the University of Ullom, provided access to the finest technology in the world. In addition, Alphia opened up its equity markets to outside investors and allowed its currency to float. Dr. Satish believes that, given time, these capital market improvements should allow the Alphian economy to achieve an economic growth rate and per capita income level comparable to any country in the world.To understand the role of technology in the growth of the Alphian economy (using neoclassical growth theory assumptions), the following table was developed to show the increased productivity of Alphian farmers using disease resistant grains. Assume new disease resistant grain technology was introduced into the Alphian farm economy at Point A.3. The New Growth Era (1991-Today)Since the Alphian energy crises of the late 1980s, the economy has been in transition. The AEDA goal is to have more than 50% of Alphian GDP coming from what we now call knowledge capital based industries by the year 2020. Given the large and growing population and their constant need for health care, the pharmaceutical industry was Alphia's first knowledge capital based industry. Dr. Satish believes that a focus on knowledge capital will enhance the long term growth prospects of Alphia's economy.According to classical growth theory, what is the real wage rate for Alphiain 1950?
Answer(s): C
Under the classical theory of growth, a one-time increase in technology (electricity) shifts the productivity curve upward, so at each and every point a higher level of real GDP per hour is created. Labor productivity in 1950 is real GDP / hours of labor in that year = $180 / 21 = $8.57 per hour. Under the classical theory of growth, a one-time shift to the productivity curve will increase wage rates one time and thus act to increase the labor force. With capital and technology held constant, a growing population translates into a greater number of labor hours, which reduces capital per hour of labor and forces the movement along the new productivity curve until the previous level of subsistence real GDP or subsistence wage level is achieved. (Study Session 4, LOS 14.d)Neither condition would allow Alphia to increase the long-term subsistence level of wages. Under the classical theory of economic growth, an economy would have a temporary improvement in the labor living standards as the real wage rate climbed above the subsistence wage rate, but over time population growth would lower capital per hour of labor and drive real GDP per hour of labor back towards the subsistence wage level. Even a greater level of savings and investment creating more capital, under classical growth theory, does not prevent this slide back towards the subsistence level of wages. Anything that increases real GDP per hour of labor above subsistence level causes population growth that overwhelms the gains from increased productivity due to a greater level of capital. (Study Session 4, LOS 14.d)
Mark Taber, CFA, is the Chief Investment Officer of the Taber Emerging Markets Fund, (TEMF). Taber uses a top-down approach to investing in countries. By interviewing government officials and the managements of foreign companies, Taber often gains economic and investment insights not yet fully understood by the foreign market. Taber is currently researching a potential investment in the emerging market country of Alphia. Taber travels to Ullom, the capital of Alphia, to discuss past, present, and future economic growth theory development with Dr. Raman Satish, managing director of the Alphia Economic Development Agency (AEDA).Dr. Satish starts the conversation with Taber by discussing the three great growth cycles that the Alphian economy has experienced over the past 120 years: (1) the classical growth era, (2) the neoclassical growth era, and (3) the new growth era. Taber takes down the following statements from the meeting with Dr. Satish's meeting.1. The Classical Growth Era of Alphia (1850-1950)This hundred-year era was noted for periodic high levels of population growth and the sporadic introductions of technology. The average Alphianian's income was very modest and the standard of living remained almost the same over the 100-year period, except when new technology was introduced. Dr. Satish cites the example of the one-time introduction of electricity to the Alphian economy from 1947 to 1950. E2. The Neoclassical Growth Era o/Alphia (1951-1990)During the neoclassical growth period, Alphia experienced a period of great economic growth. For example, from 1986 to 1990, Alphia's capital per hour of labor grew at a 9% annual rate, while real GDP grew at 7% per annum.Also, Alphia was able to achieve economic growth rates and income levels comparable with many of its neighboring countries during the neoclassical growth period. Alphian scientists, together with the engineering department of the University of Ullom, provided access to the finest technology in the world. In addition, Alphia opened up its equity markets to outside investors and allowed its currency to float. Dr. Satish believes that, given time, these capital market improvements should allow the Alphian economy to achieve an economic growth rate and per capita income level comparable to any country in the world.To understand the role of technology in the growth of the Alphian economy (using neoclassical growth theory assumptions), the following table was developed to show the increased productivity of Alphian farmers using disease resistant grains. Assume new disease resistant grain technology was introduced into the Alphian farm economy at Point A.3. The New Growth Era (1991-Today)Since the Alphian energy crises of the late 1980s, the economy has been in transition. The AEDA goal is to have more than 50% of Alphian GDP coming from what we now call knowledge capital based industries by the year 2020. Given the large and growing population and their constant need for health care, the pharmaceutical industry was Alphia's first knowledge capital based industry. Dr. Satish believes that a focus on knowledge capital will enhance the long term growth prospects of Alphia's economy.According to the classical growth theory, Alphia would:
Neither condition would allow Alphia to increase the long-term subsistence level of wages. Under the classical theory of economic growth, an economy would have a temporary improvement in the labor living standards as the real wage rate climbed above the subsistence wage rate, but over time population growth would lower capital per hour of labor and drive real GDP per hour of labor back towards the subsistence wage level. Even a greater level of savings and investment creating more capital, under classical growth theory, does not prevent this slide back towards the subsistence level of wages. Anything that increases real GDP per hour of labor above subsistence level causes population growth that overwhelms the gains from increased productivity due to a greater level of capital. (Study Session 4, LOS 14.d)
Mark Taber, CFA, is the Chief Investment Officer of the Taber Emerging Markets Fund, (TEMF). Taber uses a top-down approach to investing in countries. By interviewing government officials and the managements of foreign companies, Taber often gains economic and investment insights not yet fully understood by the foreign market. Taber is currently researching a potential investment in the emerging market country of Alphia. Taber travels to Ullom, the capital of Alphia, to discuss past, present, and future economic growth theory development with Dr. Raman Satish, managing director of the Alphia Economic Development Agency (AEDA).Dr. Satish starts the conversation with Taber by discussing the three great growth cycles that the Alphian economy has experienced over the past 120 years: (1) the classical growth era, (2) the neoclassical growth era, and (3) the new growth era. Taber takes down the following statements from the meeting with Dr. Satish's meeting.1. The Classical Growth Era of Alphia (1850-1950)This hundred-year era was noted for periodic high levels of population growth and the sporadic introductions of technology. The average Alphianian's income was very modest and the standard of living remained almost the same over the 100-year period, except when new technology was introduced. Dr. Satish cites the example of the one-time introduction of electricity to the Alphian economy from 1947 to 1950. E2. The Neoclassical Growth Era o/Alphia (1951-1990)During the neoclassical growth period, Alphia experienced a period of great economic growth. For example, from 1986 to 1990, Alphia's capital per hour of labor grew at a 9% annual rate, while real GDP grew at 7% per annum.Also, Alphia was able to achieve economic growth rates and income levels comparable with many of its neighboring countries during the neoclassical growth period. Alphian scientists, together with the engineering department of the University of Ullom, provided access to the finest technology in the world. In addition, Alphia opened up its equity markets to outside investors and allowed its currency to float. Dr. Satish believes that, given time, these capital market improvements should allow the Alphian economy to achieve an economic growth rate and per capita income level comparable to any country in the world.To understand the role of technology in the growth of the Alphian economy (using neoclassical growth theory assumptions), the following table was developed to show the increased productivity of Alphian farmers using disease resistant grains. Assume new disease resistant grain technology was introduced into the Alphian farm economy at Point A.3. The New Growth Era (1991-Today)Since the Alphian energy crises of the late 1980s, the economy has been in transition. The AEDA goal is to have more than 50% of Alphian GDP coming from what we now call knowledge capital based industries by the year 2020. Given the large and growing population and their constant need for health care, the pharmaceutical industry was Alphia's first knowledge capital based industry. Dr. Satish believes that a focus on knowledge capital will enhance the long term growth prospects of Alphia's economy.According to the neoclassical growth theory, calculate the contribution to real GDP growth during the period from 1986 to 1990 that came from an increase in capital per hour of labor.
Answer(s): B
In order to solve this problem we have to use the One-Third Rule of Robert Solow of MIT. His rule states that, with technology held constant, a 1% increase in capital per hour of labor equates to one-third of a 1% increase in real GDP per hour of labor. Thus, when capital per hour of labor increases by 9%, the one-third rule dictates that capital growth has contributed 3% (9% x 1/3) to real GDP growth. The balance of the 7% real GDP growth, or 4%, is due to technological change. (Study Session 4, LOS 14-b)
Mark Taber, CFA, is the Chief Investment Officer of the Taber Emerging Markets Fund, (TEMF). Taber uses a top-down approach to investing in countries. By interviewing government officials and the managements of foreign companies, Taber often gains economic and investment insights not yet fully understood by the foreign market. Taber is currently researching a potential investment in the emerging market country of Alphia. Taber travels to Ullom, the capital of Alphia, to discuss past, present, and future economic growth theory development with Dr. Raman Satish, managing director of the Alphia Economic Development Agency (AEDA).Dr. Satish starts the conversation with Taber by discussing the three great growth cycles that the Alphian economy has experienced over the past 120 years: (1) the classical growth era, (2) the neoclassical growth era, and (3) the new growth era. Taber takes down the following statements from the meeting with Dr. Satish's meeting.1. The Classical Growth Era of Alphia (1850-1950)This hundred-year era was noted for periodic high levels of population growth and the sporadic introductions of technology. The average Alphianian's income was very modest and the standard of living remained almost the same over the 100-year period, except when new technology was introduced. Dr. Satish cites the example of the one-time introduction of electricity to the Alphian economy from 1947 to 1950. E2. The Neoclassical Growth Era o/Alphia (1951-1990)During the neoclassical growth period, Alphia experienced a period of great economic growth. For example, from 1986 to 1990, Alphia's capital per hour of labor grew at a 9% annual rate, while real GDP grew at 7% per annum.Also, Alphia was able to achieve economic growth rates and income levels comparable with many of its neighboring countries during the neoclassical growth period. Alphian scientists, together with the engineering department of the University of Ullom, provided access to the finest technology in the world. In addition, Alphia opened up its equity markets to outside investors and allowed its currency to float. Dr. Satish believes that, given time, these capital market improvements should allow the Alphian economy to achieve an economic growth rate and per capita income level comparable to any country in the world.To understand the role of technology in the growth of the Alphian economy (using neoclassical growth theory assumptions), the following table was developed to show the increased productivity of Alphian farmers using disease resistant grains. Assume new disease resistant grain technology was introduced into the Alphian farm economy at Point A.3. The New Growth Era (1991-Today)Since the Alphian energy crises of the late 1980s, the economy has been in transition. The AEDA goal is to have more than 50% of Alphian GDP coming from what we now call knowledge capital based industries by the year 2020. Given the large and growing population and their constant need for health care, the pharmaceutical industry was Alphia's first knowledge capital based industry. Dr. Satish believes that a focus on knowledge capital will enhance the long term growth prospects of Alphia's economy.Alphia has access to the same world class technology and capital markets as its more advanced neighbors. Dr. Satish expects Alphia's economic growth rate and income level to converge to that of richer countries over time. Indicate v/hether convergence with richer countries is likely or unlikely. Convergence is:
The neoclassical growth theory model does indeed imply that given access to the same technology and capital markets, then growth rates and income levels per person should begin to converge on a global basis. While some convergence has occurred over time, many countries are just as far away from the rich countries as they have ever been. This lack of convergence in the real world is probably due to the fact that the neoclassical growth model leaves out many of the variables that must grow at the same rate in different countries for convergence to occur. Obstacles to convergence include differences in population growth rates, in rates of technological change, and most importantly in savings rates and target rates of return. In essence, if the countries do not have similar economic and demographic characteristics, then it would be difficult for them to grow at the same rate. (Study Session 4, LOS 14.d)
Mark Taber, CFA, is the Chief Investment Officer of the Taber Emerging Markets Fund, (TEMF). Taber uses a top-down approach to investing in countries. By interviewing government officials and the managements of foreign companies, Taber often gains economic and investment insights not yet fully understood by the foreign market. Taber is currently researching a potential investment in the emerging market country of Alphia. Taber travels to Ullom, the capital of Alphia, to discuss past, present, and future economic growth theory development with Dr. Raman Satish, managing director of the Alphia Economic Development Agency (AEDA).Dr. Satish starts the conversation with Taber by discussing the three great growth cycles that the Alphian economy has experienced over the past 120 years: (1) the classical growth era, (2) the neoclassical growth era, and (3) the new growth era. Taber takes down the following statements from the meeting with Dr. Satish's meeting.1. The Classical Growth Era of Alphia (1850-1950)This hundred-year era was noted for periodic high levels of population growth and the sporadic introductions of technology. The average Alphianian's income was very modest and the standard of living remained almost the same over the 100-ycar period, except when new technology was introduced. Dr. Satish cites the example of the one-time introduction of electricity to the Alphian economy from 1947 to 1950. E2. The Neoclassical Growth Era o/Alphia (1951-1990)During the neoclassical growth period, Alphia experienced a period of great economic growth. For example, from 1986 to 1990, Alphia's capital per hour of labor grew at a 9% annual rate, while real GDP grew at 7% per annum.Also, Alphia was able to achieve economic growth rates and income levels comparable with many of its neighboring countries during the neoclassical growth period. Alphian scientists, together with the engineering department of the University of Ullom, provided access to the finest technology in the world. In addition, Alphia opened up its equity markets to outside investors and allowed its currency to float. Dr. Satish believes that, given time, these capital market improvements should allow the Alphian economy to achieve an economic growth rate and per capita income level comparable to any country in the world.To understand the role of technology in the growth of the Alphian economy (using neoclassical growth theory assumptions), the following table was developed to show the increased productivity of Alphian farmers using disease resistant grains. Assume new disease resistant grain technology was introduced into the Alphian farm economy at Point A.3. The New Growth Era (1991-Today)Since the Alphian energy crises of the late 1980s, the economy has been in transition. The AEDA goal is to have more than 50% of Alphian GDP coming from what we now call knowledge capital based industries by the year 2020. Given the large and growing population and their constant need for health care, the pharmaceutical industry was Alphia's first knowledge capital based industry. Dr. Satish believes that a focus on knowledge capital will enhance the long term growth prospects of Alphia's economy.Alphia has access to the same world class technology and capital markets as its more advanced neighbors. Dr. Satish expects Alphia's economic growth rate and income level to converge to that of richer countries over time. Indicate v/hether convergence with richer countries is likely or unlikely. Convergence is:Based on the neoclassical growth model, indicate at what point the Alphian farmers would find economic equilibrium after the introduction of disease resistant grains.
Equilibrium in the neoclassical model occurs when the target rate of return equals the real interest rates equal the target interest rates. Real interest rates are those rates achieved in the market, while target interest rates are those rates of return the investor wishes to earn.Equilibrium occurs at Point A and at Point C. However, as a result of adding disease resistant grain to the Alphian farmers, these farmers are operating on a higher productivity curve than the original Point A. At Point B the real interest rate is higher than the target interest rate, inducing more capital to be invested. At Point C the target rate of interest is equal to the real rate of interest, creating an equilibrium. (Study Session 4, LOS l4.d)
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