Economics of Global Business

Problem Set #2
DUE: @ 11am on March 04

Submit via Assignments at NYU Classes. Make sure you submit one single file with all your
answers (pdf file is preferred). Submissions by email will not be accepted. You may work in a
group of up to 5 people. Whatever you hand in should be the work of your group and it should
take to form of a professional piece of work. Submit one assignment per group.

1. Labor Market

Consider an economy with production function given by Y = AK 0.5 L0.5 where A is the total factor
productivity (TFP), K is the capital stock and L is the labor input. For simplicity assume capital is
fixed and equal to 1. Assume A=100.
a. Write the firm’s problem of choosing labor demand. Derive the demand for labor as a function
of the real wage.

b. Assume labor supply is inelastic and fixed at L̄ = 25. Find the equilibrium values of the wage
and the employment level for this economy. Display graphically the labor supply and the labor
demand curves. Carefully label your graph.

c. Suppose the economy faces a positive productivity shock and TFP is now A=150. Display
graphically the new labor demand function. What are the equilibrium values of employment and
the real wage?

d. Compute the total output when A=100 and when A=150. What is the output’s growth rate?
Compare that growth rate with the growth rate in A. How does the growth rate of output per
capita compares to the growth rate in A? Explain carefully.

2. Emerging Market Forecasting and Growth Accounting

What drives GDP growth in China and India? How do they compare to each other? Data on real
GDP, capital, employment, are in the country data file, available on the course website. Assume
that payments to labor make up two-thirds of GDP in both countries, i.e., 1 − α = 2/3.

a. How has GDP per worker evolved in the two countries? Turn in one well-labeled graph that
plots GDP per worker (1979–2019) for both countries.

b. Compute TFP for each year. Create a TFP index for each country by dividing the value of TFP
in each year by the value of TFP in 1979 and multiplying by 100. Turn in one well-labeled graph
showing (1979–2019) the two TFP indices.

c. Compute the marginal product of capital (i.e. the MPK) for each year. Turn in one well-labeled
graph showing (1979–2019) the MPKs for each country.

Revised: February 16, 2021

Economics of Global Business Emerging Market Forecasting and Growth Accounting

China Y /L αK/L TFP

1979–1990
1990–2019

India Y /L αK/L TFP

1979–1990
1990–2019

d. Separate each country’s growth experience into two periods: 1979-1990 and 1990-2019. De-
compose the growth in output per worker into contributions from TFP, capital per worker, and
these two periods. Report your findings in the tables below.
e. Prepare a short summary of growth in China and India, highlighting the similarities and differences
between the two countries (including any differences that arise in the two periods). In your report,
please address several questions
• Which of the growth accounting elements are most important?
• How have returns on capital evolved over this time period? How do the evolution of returns
relate to the accounting exercise?
• What are possible reasons for the evolution of productivity in these two countries. In doing
so, you should explore the World Bank’s Doing Business reports and Governance Indicators.

Revised: February 16, 2021