Question 4

Suppose we wanted to use the Cobb-Douglas production function

Y=AK1/3L2/3

to explain differences in income between Japan and Australia.

(a) If Japan has higher capital per worker than Australia, would we then expect Japan to have a higher or lower income per capita than Australia? Explain in words.

[2 marks]

(b) Following from part (a), we then find that Australia has higher income per capita. What does this suggest about Australias total factor productivity relative to Japans? Explain in words.

[2 marks]

(c) Now suppose that Japan has higher human capital than Australia. Give two other possible reasons that could explain the differences in total factor productivity between the two countries.

[2 marks]

(d) Now suppose a Japanese politician wants to promote additional capital accumulation in order for Japans income per capita to overtake Australias. In the context of the Solow model, explain in words why capital accumulation by itself cannot lead to continued increases in income per capita.

[4 marks]

[Total for Question 4 = 10 marks]