Suppose there are two groups of people in the economy. In groupj, individual i accumulates human capital

according to

Hi=b(1u)(aHi+(1a)Hj),

where Hi is theindividual's human capital in the futureperiod, 0

a. What happens to incomes in groups 1 and 2 in the longrun?

In the longrun,

A.

incomes of individuals within group 1 will converge and incomes of individuals within group 2 will also converge. The net effect is convergence of incomes between groups 1 and 2.

B.

human capital will grow faster in whichever group has a lower average human capital. As aresult, incomes will grow faster in the group with the lower average human capital. There will be a convergence in incomes between groups 1 and 2. The growth rate of human capital and income will be constant amongst individuals within each group.

C.

incomes of individuals within group 1 will converge and incomes of individuals within group 2 will also converge. The differences in income levels between groups 1 and 2 will persist.

D.

growth rates of income for individuals in groups 1 and 2 will remain constant because all individuals choose the same value of u, and b is not defined.

b. What does this say about the role of human capital accumulation in incomeinequality?

Human capital accumulation

A.

is only capable of influencing levels of income inequality when low human capital individuals are willing to dedicate more of their time to the accumulation of human capital.Therefore, income inequality is eliminated in the long run if low human capital individuals have higher values ofu, and will persist if the value of u is constant across individuals and groups.

B.

is the only economic mechanism that can eliminate income inequality across economies in the endogenous growth model. Human capital externalities can increase the rate with which low initial human capital economies converge with high initial human capital economies.

C.

can be influenced by human capital externalities and therefore can contribute to reducing the level of income inequality within groups of the economy.However, income inequality across groups of the economy and across economies will persist.

D.

rates for low initial human capital individuals can be increased by human capital externalities. The existence of human capital externalities results in the elimination of income inequality in the long run within groups of aneconomy, across groups of aneconomy, and across economies.