Economic Environment of Business: Test 1

10 April 2021

1. Effect of Globalization on Inequality:

With increased income inequality in countries like USA and India, one of
the oft repeated claims is that globalization increases income inequality by
moving labour intensive jobs from regions of relative prosperity to regions
where unskilled labor is more readily available. The counter-argument to
that is such changes prompt re-assessment of Occupational Choice and,
therefore, either the affected labor force update their skills and relocate
to other sectors or choose suitable educational variables for their children
so as facilitate that reallocation in the next generation.

(a) Consider the above mentioned Occupational Choice route for a coun-
try like Philippines where a lot of technology based services are mov-
ing. Philippines is a medium income country with a sizeable pool of
skilled labor with relatively high cost associated with higher educa-
tion. It is also a country with a deep rooted history of skewed income
distribution. Will suitable occupational choice lead to a decrease in
income inequality? Explain. (10 marks)
(Hint: To understand one of the several viewpoints, read
www.econstor.eu/bitstream/10419/221270/1/cmsems-dp0911.pdf.
You may read only the Abstract to get the gist. The Introduction is
useful too.)
(b) Consider the impact of globalization on Philippines and Sierra Leone.
One is a middle income country with a sizable skilled labor force.
The other is poor country with sizable unskilled population. Due to
globalization, Sierra Leone will see an increase in export of products
that are labor intensive while Philippines will export goods that are
more technology intensive in nature. That, of course, means ’factor-
price equalization’ for labor that is actively used by the traded sector.
What is the implication for income inequality? Will the implications
be different for Philippines as opposed to Sierra Leone. Explain your
answer. (10 marks)

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2. Growth Accounting

Consider the following production function for a developed economy, Akka-

dia: Y t = At Ktα L1−α
t , where Y is total output, K is capital, L is labor
and α is a positive constant less than 1. Assume: α = 0.75. The pop-
ulation of Akkadia in period t is Nt , output per capita is denoted by yt ,
capital per capita by kt , and labor per capita by lt . A is growing at a rate
gA , k is growing at the rate gk and l is growing at the rate gl and y is
growing at the rate gy .

(a) What is the marginal product of capital? Is this an increasing, de-

creasing or constant function of K? Plot marginal product of capital
as a function of K taking L = 1, A = 4. What is the significance
of the shape of marginal product of capital function in the context
of economic growth? Explain. Derive any relation you are using to
answer this question. (10 marks)
(b) Holding labor input constant, why is technology growth required for
sustained increase in per capita GDP, particularly for a country like
Akkadia? Explain with the help of the growth accounting relation.
(5 marks)
(c) Why is At referred to as the technology parameter? How do we
measure gA ? Discuss the pros and cons of this measure. (5 marks)

3. Solow Growth Model:

Consider a standard Solow Model with constant technology with produc-

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tion function given by Y = K 2 N 2 , where Y is the GDP, K is the capital
and N the population. Average savings rate of the country is 0.1. Popu-
lation growth rate is 0.02 and average depreciation rate is 0.03. Draw the
‘usual Solow Graph’ and explain what the curves represent. How is the
steady state defined in this case? What is the value of steady state GDP
per capita and what is the steady state level of consumption per capita?
Is this consumption per capita (level) optimal? How would you answer
that question? Find the optimal value of savings rate to achieve that.
(10 marks)