Problem Set 4 FE411 Fall 2014 Rahman. Some Answers. 1) Composition Effects of Population Growth

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1 Some Answers 1) Composition Effects of Population Growth Suppose that the world has only two countries. The following table gives data on their populations and GDP per capita. It also shows the growth rates of population and GDP. The growth rates of population and GDP per captia in each country never change. Country Population in 2000 GDP per Capita in 2000 Growth Rate of Population (% per year) Country A 1,000, Country B 1,000, Growth Rate of GDP per Capita (% per year) a. What will the growth rate of world population be in the year 2000? Following 2000, will the growth rate of world population rise or fall? Explain why. Draw a graph showing the growth rate of world population starting in 2000 and continuing in to the future. Toward what growth rate does the world population move in the long run? Growth Rate of World Population 2 % 1 % time Page 1 of 7

2 b. Draw a similar graph showing the growth rate of total world GDP. Growth Rate of Total World GDP 2 % 1 % time c. Draw a similar graph shoing the growth rate of average GDP per capita in the world. Page 2 of 7

3 Growth Rate of Average GDP per Capita 1 % 0 % time Page 3 of 7

4 2) Education as a Form of Human Capital Accumulation Read 6.2 and 6.3 of the Weil text, which describes how years of education translates in to human capital, and how his human capital in turn translates into additional income. Use the insights from these sections to answer the following: a. What fraction of wages is due to human capital for a worker who has nine years of education? The wage for an individual with nine years of education, relative to one with no education, is (1.134) 4 (1.101) 4 (1.068) In other words, if the wage of an individual with no education is W, the wage paid to this individual is 2.6W. Therefore, we can conclude that the payment to raw labor is W and the payment to human capital is the difference between the total wage and the wage for raw labor. To find the fraction, we compute, Payment to Human Capital/Total Payment The fraction of wages paid to human capital is 61.5 percent b. In a certain country, everyone in the labor force in the year 2000 had 12 years of education. In 1900 everyone in the labor force had 2 years of education. What was the annual growth in income per worker that was due to the increase in education? The relative return to 12 years of schooling is 3.16, and the relative return to two years of schooling is (1.134) 2 or Writing the steady-state ratio for one country over time and denoting h and h , we get: y h , s 20 y 190, s h Thus, the ratio of steady-state output per worker for this country over time is If over 100 years, the steady-state output has increased by a factor of 2.45, we can solve for the growth rate, g, by the following calculation g (2.45) We conclude that the annual average growth rate of output per worker is 0.9 percent. Page 4 of 7

5 3) Cross-Country Comparison Say the production function for all countries is given by that shown on page 170. Suppose countries i and j are similar in every respect expect in country i all adults have 10 years of schooling, while in country j all adults have 4 years of schooling. Calculate the ratio of output per worker in steady state in the two countries. Years of Schooling* Wage Relative to No Schooling* Percentage of People Relative Wage Paid to Human Capital Total Relative Wage No Schooling % Partial Primary % Complete Primary % Incomplete Secondary % Complete Secondary % Incomplete Higher % Complete Higher % Sum *The first two columns of the table above are replicated from Table 6.2. The relative return to 10 years of schooling is 2.77, and the relative return to four years of schooling is 1.65 (from the table above). Denoting hi 2.77 and h j 1.65, we can solve for the steady-state ratio for two countries identical in every respect expect for education as follows: yis, hi y h 1.65 js, Thus, the ratio of output per worker in the steady state is j Page 5 of 7

6 4) An Alternative Production Function with Human Capital Consider a Cobb-Douglas production function with three inputs. K is capital (the number of machines), L is labor (the number of workers), and H is human capital (the number of college degrees among the workers). The production function is: Y K 1/3 L a. Derive an expression for the marginal product of labor. How does an increase in the amount of human capital affect the marginal product of labor? 1/3 MPL = 1/3*K 1/3 H 1/3 L -2/3. Increase in human capital raises MPL. H 1/3 b. Derive an expression for the marginal product of human capital. How does an increase in the amount of human capital affect the marginal product of human capital? MPH = 1/3*K 1/3 H -2/3 L 1/3. Increase in human capital lowers MPH. c. What is the income share paid to labor? What is the income share paid to human capital? In the national income accounts of this economy, what share of total income do you think all workers would appear to receive? 1/3, 1/3, and 2/3, respectively. d. Say an unskilled worker earns the marginal product of labor, whereas a skilled worker earns the marginal product of labor plus the marginal product of human capital. Using your answers to (a) and (b), find the ratio of the skilled wage to the unskilled wage. How dies an increase in the amount of human capital affect this ratio? Explain. W skilled /W unskilled = (MPL + MPH) / MPL = 1 + (L/H). When H increases, this ratio falls because the diminishing returns to human capital lower its return, while at the same time increasing the marginal product of unskilled workers. Page 6 of 7

7 e. Some people advocate government funding of college scholarships as a way of creating a more egalitarian society. Others argue that scholarships help only those who are able to go to college. Do your answers to the preceding questions shed light on this debate? If more college scholarships increase H, then it does lead to a more egalitarian society. The policy lowers the returns to education, decreasing the gap between the wages of more and less educated workers. More importantly, the policy even raises the absolute wage of unskilled workers because their marginal product rises when the number of skilled workers rises. 5) Physical and Human Capital as Perfect Complements Consider two countries, Sri Lanka and Japan. Both countries have a production function per person where physical capital per person (k) and human capital per person (h) are the only two inputs in production. Specifically, the production function per person is: y min[ k, h] Suppose Sri Lanka has a low rate of physical capital investment, a large h, and a very low k. Japan on the other hand as a high rate of physical capital investment, a large h, and a moderate amount of k. Both countries are the same in all other respects. a. Which country do you predict will grow faster in the short term? Why? Japan. Because both countries have large h s, we would expect physical capital per person to be the relatively scare factor, so only growth in k will allow growth in y. Thus in the short run, Japan should grow faster because its investment rate in physical capital is higher. b. Which country do you predict will grow faster in the long term? Why? Sri Lanka. Once Japan has large levels of both k and h, its growth stops - once k = h, further increases in k does nothing to increase y. Since Sri Lanka starts with such an imbalanced situation, where k <<< h, it can grow for a much longer period of time by increasing k though physical capital investment. Page 7 of 7