Econ 202 Proble m Set 8 Solutions Global Growth, inequality. Creative Destruction, and Employment Reading: The Economy 2.0 Microeconomics Unit 1.1 to 1.5 Reading: The Economy 1.0 Unit 16, Intro, 16.2 to 16.9, 16.12 and 16.13 1) Technological innovations and economic growth a) What is the definition of Real GDP per capita and is it used to measure? R eal GDP per capita = real GDP/Population and is a measure of a country's average real income or standard of living b) How does Real GDP per capita depend on labor productivity? Real GDP per capital (Y/population) is proportional to output per worker = labor productivity Y/N= π . Hence a country β s real GDP per capita (average standard of living) increases if labor productivity increases c) What causes labor productivity (and hence a country β s standard of living) to increase? Labor productivity ( Y/N= π ) increases β’ If the education and skill level of workers increases β’ if in the amount of equipment that workers work with increases β’ due to technological innovations 2) Tech no logical change and the profit motive a) H o w do the in centives of capitalist firms result in ac tivit ies that result in technol ogic al in n o vations? Capi t alist firms have the incentive to ma ximize profits. Te ch nological inn ovations create new produc t s and /or increase labor productivity ( βΞ» ) thus lowering unit labor cos ts ( β W/ Ξ» ) w hich increases pro fits Technological innovations require that firms invest in research and development b y hiring scientists and engineers and having labs to do research. b) O nce an innovation occur s typically the new technology is embedded in new equipment What does adopting a new technology typically require in addition to the purchase of new equipment and structures (investment) that embeds the new technology? N ew technology often requires workers learn new labor skills , which i n turn often requi res literate and numerate workers who can learn. c) Draw a flow di agram that connec ts the capitalist profit motive , technological in novations to increases in real GDP per capita ( β standard of living) profit motive β technological innovation β β labor productivity β β real GDP per capita 3) What are four l egacies of t he I ndustrial Rev olu tion as dis cussed in c lass and the lecture notes? 1 s t Legacy of the I ndustrial Revolution is the switch around 1760 from stagnate per capita r eal income to sustained economic growth in at least some counties A 2 nd legacy of the Industrial revolution is the β Great Di ve rgence β that is the increase in income inequality between countries. A 3 rd legacy of The Industrial Revolution and rise of the globalized economy is the decrease extreme poverty around the world A 4 th legacy of the fo ssil fuel powered Industrial Revolution is climate change. 4) Global income inequa l ity? a) The Industri al Revolution result ed in a dramatic increase in income inequal ity between countries. W hat is the pro x i m at e cause for income inequality between countries ? T he pro x i m at e cause for income inequality between countries is d ifferences in labor prod ucti vity. Lower per capita income countries have lower labor productivity Higher per capita countries have higher labor productivity The next question is what explains differences in labor productivity across countries ? One explanation would be differences in incentives to devel opment and invest in new technologies and differences in the ability of workers to obtain the necessary skills an education needed to use new technologies which drives higher labor productivity Hold it right there b) How does the WS PS model e xplain income inequality wi thin a countr y? In problem set 2 we discussed how to derive the Gini coefficient for the wage setting price setting model I n the WS PS model h igher inequality within a country (a higher Gini coefficient ) is due to: β’ greater monopoly power by firms in the product market monopoly power in the labor market resulting in a higher profit share of output ( βΟ ) increases income inequality β’ greater concentration of ownership among fewer owners increases income inequality β’ higher unemployment rate increases income inequality 5) W hy is technolog i cal innovation also called β creative destruction β ? What is created and what is dest royed due to techno logical innovations? Who wins and who loses due to technological innovations? Give a real - world example Te chnol ogical innovations create new products or lowers the cost of producing existing products This is the creative part ohh creative destruction The owners of firm s doing successful technological innovation s gain higher profits , new jobs are potentially created and consumers g ain by enjoying new p roducts or lower pr ices for existing products Technological innovations also make old products and ways of producing goods obsolete This reduces the profits of the owners of firms using the old technology , and destroys jobs of workers in the old technology firms An example is the invention of the automobile The automotive innovators such as Henry Ford enjoyed high profits , new jobs were created producing automobiles using an assembly line methodology , consumers enjoyed the new technology , the automobile At the same time the automobile destroyed businesses involved with horses and carriages and destroyed the jobs of workers working for those businesses 6) Beveridge Curve graphs the re lationship between the unemployment rate and the job vacancy rates a) what is the difference between the unemployment rate and the job vacancy ra te? The unemployment rate is the fraction of the labor force which is unemployed , that is not working , and also looking for work The job vacancy rates is the number of job openings as a fraction of the labor force A firm has a job opening i f the firm has an unfilled job and is looking for a worker to fill the job. b) Why does the Beveridge Curve have a negative slope? What does th e negative slope of the curve imply about the correlation between unemployment and the vacancy rate ? Causal explanation for the negative slope of the BC: In Recessions β AD β firms β Y β firms lay off workers & β searches for new workers hence we observe high unemployment and low vacancies at the same time. In expansions β AD β firms β Y β firms hire more workers & β searches for new workers hence we observe low unemployment and high vacancies at the same time. H ence the correlation between the unemployment rate and the job vacancy rate is negative c) How does t he position of the Beveridge Curve depend on the efficiency of the labor market matching process ? I f unemployed workers and open jobs are matched more quickly so the job matching process is more efficient then both the unemployment rate and the job vacancy rates will be lower This implies i f the labor market matching process get more efficient the B ever i d ge C urve shifts left. If the labor market matching process get less efficient , So it takes longer to match unemployed workers with vacant jobs then the B everi d ge C urve shifts right. d) H ow m ight technological innovations a ffect the effici ency of the job matching process and hence the position of the B ever id ge C urve ? Technological innovation is a creative destructive process New jobs are created using the new technology , an d jobs that used the old technology are destroyed T echnological innovation may temporarily increase the mismatch between the skill of unemploy ed workers from the old obsolete job s and the required skill s of new jobs using the new technology the new technology renders the old worker skill set obsolete Hence , higher unemployment is associated with higher job vacancy rates This implies that the B ever id ge C urve shifts right 7 ) T h e Di ffusion Gap : A source of messy transition due to tech nological change a ) What is the β di f fusi on gap β associated with technological change? The (Innovation) Diffusion Gap = lag time between the first firm to adopt an innovation and its general use b) What are t wo causes of an increase in the di f fusion gap? The innovating firms have an incentive to block entry by new firms and may be able to block new firms from adopting the new technology using patents and trade secrets. This can increase the Diffusion Gap. Workers and owners of firms with the old technology also lobby for protection through government subsidies, tariff protection and bailouts that guarantee at least for a while the survival of low productivity firms and jobs. Such lobbying also increases the Diffusion Gap. 8 ) Using the WS PS model to think about technological innovation, unemployment creative destruction a) Draw the WS PS model graph for a supply side eq uil ibrium. Lab el the initial equilib riu m p oint A. Suppose there is a te chno logical in n o vation w hich increases labor productivity β Ξ» Show which curve shifts. La bel the new supply side equ i li brium point D b ) N ow indicate in the graph the transition from the initial supply side equilibrium point A to the eventual equilibrium , point D assuming that initially the number of firms and the level of output remains unchanged Label this point B What's true about unemployment and profit s at point B relative to point A c) Gi ve n your answer for the level of profits at point B , what happens to employment (la bel this point C your graph ) and hence wages (label this point D in yo ur graph ) ? Gr aph f or parts a ), b ) c) Comparing point B to point A: unemployment is higher and profits are higher as well higher profits c ause owners to create new firms or Expand the size of existing firms Either way employment increases : point B to C At point C lower unemployment ββ COJL β firms HR departments β W to recruit, retain and incentivize workers to not shirk: point C to D d) What will slow down the transition from Point s A to B, to C to D ? The transition from points A to D takes longer if: β’ there are barriers to entry of new firms which slows down the diffusion of the new technology β’ there is a mismatch between skills of unemployed workers and skilled required by new jobs, so unemployed workers need to acquire new skills β’ if there is a mismatch than the location of the unemployed workers and the location of the new job vacancies e ) What happens to income inequa lity as the economy move s from point A to point B to point C to point D? Income inequality increases in the short run from point A to B due to higher unemployment and a temporarily higher profit share of output. Point s B to C income inequality dec reases due to decreasing unemployment and decreases from point C to D due to increased wages.