Fatih University

Department of Economics
Economic Growth and Economic Development I
Instructor: Prof. Dr. Alexi Danchev
Test on Solow model.
Registration No. Name of the students
Group Time allowed one academic hours.
Maximum scores = 40.

Answer all questions. All questions carry equal marks. There are no penalties for
incorrect answers. For each question, circle the appropriate letter. Do not circle more than
one letter. If you wish to change your answer, clearly cross out your first selection.
Ambiguous or unclear responses will be regarded as incorrect answers.

Section I. TRUE / FALSE QUESTIONS.

(circle the correct answer)

1 TRUE FALSE Per capita output is an increasing function of the capital-labour ratio and is
subject to diminishing marginal productivity of capital.

2 TRUE FALSE The rate of per capita capital accumulation that maintains a constant capital-
labour ratio is normally shown as the ray having a slope equal to the growth
rate of the population

3 TRUE FALSE If the savings rate rises from (1 - bo) to (1 - bl) the savings function shifts
downwards.

4 TRUE FALSE The level of the capital/labour ratio at which the growth rates of capital and
labour are equal is called the steady-state

5 TRUE FALSE Solow—Swan model has a great defect as an explanation of economic growth
in the real world because in the model, there is no growth of output per worker
in the very long run (the steady state);

Section II. MULTIPLE CHOICE QUESTIONS.

(circle the correct answer)

1. Which of the following countries had the fastest rate of economic growth since 1950s
a. United States
b. United Kingdom
c. Germany
d. Japan
e. Turkey

2. When we study economic growth we are most concerned about changes in

a. the capital- output ratio
b. the level of natural real output
c. the absolute difference between natural and actual real output
d. output per capita
 e. none of these

3. When an equal percentage increase in the factors of production raises real GNP
by
the same percentage, the production function has the characteristic known as
a. constant returns to scale
b. constant marginal productivity
c. diminishing marginal productivity
d. increasing returns to scale
e. decreasing returns to scale.

4. The application of Solow’s growth theory to the explanation of the slowdown in

productivity growth in the U.S. suggests that the slowdown is primarily caused by
a. reduced growth in the capital stock per hour of work
b. reduced growth in the technical change or total factor productivity
c. slow residual growth of the capital stock
d. ignorance since people save and invest less
e. the changes in the global warming

5. The investment required to maintain steady state growth

a. is impossible to achieve since capital for new workers requires continuous increases
in s, the per capita savings ratio
b. must equip new workers with capital equal to that employed by existing workers
c. must replace “worn out” capital
d. b and c
e. none of above

6. Suppose that the government passes a law requiring households to increase savings
10% above previous levels. According to Solow’s growth theory, in the short run
a. output per capita grows more rapidly
b. output per capita grows at the constant steady state rate, n
C. output per capita stays constant
D. all of the above
e. none of the above

7. Suppose that the U.S. adopted a new immigration policy with respect to Eastern
Europe, which allowed all highly skilled Eastern Europeans who so desired to
immigrate to the U.S. Preliminary studies indicate that the majority of immigrants
would be doctors, computer programmers, scientists and economists. In the short
run we would expect
a. the GNP per capita to rise as the production function shifts upward
b. the GNP per capita to fall even though total production increases
c. the GNP per capita to rise as the production function shifts downward
d. none of the above are correct

Figure 12-1
 OUTPUT PER HEAD

H I

B C P
0
Q/N = AoF(K/N)
E F

(K/N)0 CAPITAL PER WORKER

8. Initially, the economy is at point B on Figure 12-1. According to the Solow growth
model, an increase in the output per capita without an increase in capital per
worker is represented by and could be the result of
______

a. the movement B to E; new technology discoveries

b. the movement B to H; improved health and education per worker
c. the movement B to C; an increase in the savings rate d. the movement B to F; a
decrease in the savings rate

9. Initially, the economy is at point B on Figure 12-1. According to the Solow model
of growth, in the short run, the discovery of a cold fusion process which reduces
the cost of energy by 50%, ceteris paribus, will shift the economy from _____

a. B to H, increasing per capita output without increasing capital per capita

b. B to C, increasing per capita output with increasing capital per capita
c. B to C, increasing per capita output without increasing savings
d. B to I, increasing output, saving and capital per capita

10. If the economy is characterized by increasing returns to scale then a

a. a doubling of inputs will lead to a more than two-fold increase in output
b. a doubling of inputs will lead to a constant output
c. doubling of inputs will lead to a two-fold increase in output
d. doubling of inputs will lead to a less than two-fold increase in output
e. none of above

11. Which of the following is true

a. the further an economy is below its steady-state value of k, the faster the economy grows.
b. the further an economy is above its steady-state value of k, the faster the economy grows.
c. the closer an economy is to its steady-state value of k, the faster the economy grows.
d. the further an economy is below its steady-state value of k, the slower the economy grows.
e. None of above

12. The growth of output is a weighted average of

a. The growth of capital and technical progress
b. The growth of labor and technical progress
c. The growth of capital and the growth of labour.
d. The growth of depreciation and population
e. The growth of saving ratio and capital/labor ratio

13. The higher steady state has

a. higher output per worker
b. increase of labour force
c. lower output per worker
d. lower consumption per worker
e. all of the above.

14. From the Golden Rule is follows that

a. The marginal product of capital is more than the population growth rate.
b. The marginal product of capital is equal to the population growth rate.
c. The marginal product of capital is less that to the population growth rate.
d. The marginal product of capital is independent on the population growth rate.
e. The marginal product of capital is proportional to the population growth rate.

15. The golden rule gives answer of the question:

a. how much saving is desirable
b. how much income should be saved to reach the highest possible level of per capita
consumption (public and private) in the steady state, given the population growth and the state
of technology
c. how much should be the rate of depreciation
d. a plus b
e. b plus c

16. Feldstein-Horioka puzzle means that

a. Countries that save more tend to invest more.
b. The investment and saving should be disconnected
c. Both investment and saving depend on consumption
d. Saving is independent on the growth rates of economy.
e. The growth rates are weighted average of the growth of capital plus the growth of labor.

17. Dynamic inefficiency means that

a. If the capital-labour ratio exceeds its steady state value, too much capital has been
accumulated.
b. By reducing savings now, an economy can consume more today and in the future.
c. Dynamically inefficient economies simply invest too much and consume too little.
d. It is illustrated by the economies of Eastern Europe during the centrally planned system.
e. All of the above.

18. A balanced growth path is a situation in which

a. capital, output, consumption, and population are growing at increasing rates.
b. capital, output, consumption, and population are growing at decreasing rates.
c. capital, output, consumption, and population are not growing at all.
d. capital, output, consumption, and population are growing at constant rates.
e. capital, output, consumption, and population are independent in their growth rates.

Section III. SHORT THEORETICAL ESSAY.

Explain the basic drawbacks of exogenous growth theory.

Section IV. REVIEW ESSAY QUESTIONS.

Please, answer ONLY ONE of the following questions:
(it is desirable to support the answers of the questions with graphical illustrations).
 1. Can a production function have the properties of diminishing returns and constant
returns to scale at the same time? Explain your answer by pointing out the difference
between these two concepts.

2. Why was the Harrod-Domar model of economic growth incomplete and how did Solow
improve upon it in his theory of economic growth?

Correct answers:
Section I. TRUE / FALSE QUESTIONS.
1 2 3 4 5
TRUE TRUE FALSE TRUE TRUE

Section II. MULTIPLE CHOICE QUESTIONS.

1 2 3 4 5 6 7 8 9 10
D D A B D B C B D C
11 12 13 14 15 16 17 18
A C E B D A E D

Section IV. CASE STUDY QUESTIONS.

1. Yes. In fact, production functions are usually assumed to be characterized by

both diminishing returns and constant returns to scale (e.g. the Cobb-Douglas
production function). A production function has the property of diminishing
“marginal” returns when the employment of each additional unit of one of the input
factors, while holding the others constant, reduces the amount by which total output
increases (i.e., the marginal product of that input factor). However, the concept of
constant-returns-to-scale implies that if all of the input factors are increased by a
certain proportion, then the output level will rise by exactly that same proportion. In
mathematical terms, functions of this type are called “homogeneous of degree one” or
“linearly homogeneous.” To see these relationships more clearly, consider the
standard Cobb-Douglas production function:
Q = AKbN1-b, b> 1.
Because the capital elasticity of real GNP, b, is less than one, every unit increase in
the capital stock while holding the quantity of labor fixed will increase output by less,
i.e., the change in the level of output falls as the capital stock continues rise. Thus,
this production function exhibits diminishing returns in capital, and the same result is
true of changes in the quantity of labor. However, because the labor elasticity of real
GNP is (1-b), every one percent increase in both capital and labor will increase the
level of output by b + (1 - b) = 1 percent. Thus, this production function also exhibits
constant returns to scale. Note also that while these two concepts are identical in
functions of one independent variable, they are generally two distinct concepts.

2. 2. The original Harrod-Domar model of economic growth was developed in two

fundamental steps. First, the identity that saving equals investment (S = I) was
combined with the definition of investment to arrive at an
identity which relates the level of national saving to the growth rate of capital and the
capital depreciation rate:

S = (∆K/K + d) K.
Secondly, the steady state condition that the growth rate of capital stock must equal
the population growth rate (k = n) was incorporated to develop the theoretical steady
state condition that the saving per unit of capital equals the sum of the population
growth rate and the depreciation rate:
SQ/K = n + d. K
However, this model was said to have “knife-edge stability” in that there was no
equilibrating forces which guided the seemingly independent factors to be consistent
with the steady state condition. Solow solved this problem by incorporating the per-
person production function into the model:
SQ/N = (n + d) . K/N
and recognizing that when (K/N) is growing faster than (Q/N), the need for workers
and depreciation capital is in excess of total saving, so that (K/N) will eventually fall
until ∆(K/N) = 0 and the steady state condition is satisfied. Thus, the important aspect
that the production function added was the property of diminishing returns
to the capital-labor ratio.