CHAPTER REVIEW

FACTS AND TOOLS

Question 7.9

1. Look at Figure 7.1. About how many babies die before the age of 5 in Nigeria versus Argentina? What is the difference in GDP per person in those two countries?

Question 7.10

2. Look at Figure 7.2. About what fraction of the world’s population lives in countries richer than Italy? What fraction lives in countries poorer than India?

Question 7.11

3. The world’s average (mean) GDP per capita is $10,515. There are roughly 7 billion people in the world.

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  1. What is the world’s total GDP?

  2. About 20% of the world’s population produces 50% of the world’s total GDP. (Notice the use of “produces,” not “consumes.” In popular discussion, you are more likely to hear about the people at the top “consuming” more than their share, not “producing” more than their share. But remember what the last letter of GDP stands for!) How much GDP does the top 20% produce?

  3. What is the average GDP per capita of the most productive 20% of the world’s population? (Hint: 20% of 7 billion people equals how many people?)

Question 7.12

4. Now let’s look at the productivity of the world’s least productive 80%.

  1. How much GDP do they produce? (Hint: You’ve already calculated this number in the previous question.)

  2. What is the average GDP per capita of the least productive 80% of the world’s population?

  3. Now, the payoff: How productive is the average person in the top 20% compared with the average person in the bottom 80% of the planet? Answer this by dividing your answer to question 3c by your answer to question 4b. This chapter and the next are devoted to explaining why this ratio is so large.

Question 7.13

5. According to Fact Two, what would your answer to question 4c have been if you calculated it 2,000 years ago?

Question 7.14

6. What are the factors of production? Name them and briefly describe them in plain English.

Question 7.15

7. Using data from the Penn World Tables, calculate the annual growth rate of real GDP per person for China for the years in the table. The Penn World Tables, available free online, are a reliable source of international economic data, and they are very popular among economists.

Year

Real GDP per Capita (in 1996 U.S. dollars)

Annual Growth Rate

2000

4,001

 

2001

4,389

_______

2002

4,847

_______

2003

5,321

_______

2004

5,771

_______

Question 7.16

8. Practice with the rule of 70: If you inherit $10,000 this year and you invest your money so that it grows 7% per year, how many years will it take for your investment to be worth $20,000? $40,000? $160,000? (Note: Investments in stocks have grown at an average inflation-adjusted rate of 7% per year since the U.S. Civil War. We’ll practice this some more in Chapter 8.)

Value today: $10,000. Growth rate: 7%

Number of years until money doubles: _____

Number of years until money quadruples: _____

Number of years until your inheritance is 16X larger: _____

Question 7.17

9. More practice with the rule of 70: Suppose that instead, you put your money into a savings account that grows at an inflation-adjusted return of 2% per year. How many years will it take to be worth $20,000? $40,000? $160,000? (Note: Bank deposits have grown at roughly this rate over the last 50 years in the United States.)

Value today: $10,000. Growth rate: 2%

Number of years until money doubles: _____

Number of years until money quadruples: _____

Number of years until your inheritance is 16X larger: _____

Question 7.18

10. India and China come up a lot in this chapter. You might wonder why so much time is spent talking about just two countries out of more than 180 on the planet. But what fraction of humans live in India and China together?

Question 7.19

11. Let’s convert Figure 7.5 into words.

Institutions create _____, which in turn affect the amount of _____, _____, and _____ in a country, which, combined with the right kind of _____, generates a level of_per person.

Question 7.20

12. In the CIA World Factbook, GDP per capita in the United States in 2010 was approximately $47,400. The formula for growth for any given year, y, is yt = y0 ( l + gy), where y0 is the value of GDP in the beginning year, yt is the value of GDP for the specific year in question, and t is the number of years after y0. If y0 is GDP per capita in 2010 and the economy continues to grow at approximately 3% as it did in 2010, what will be the value of GDP per capita in 10 years?

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THINKING AND PROBLEM SOLVING

Question 7.21

1. The average person in Argentina today is about as rich (in inflation-adjusted terms) as his or her parents. How can this be called a “growth disaster”?

Question 7.22

2. Before the rise of affordable automobiles and subways, many people used trolleys—small trains on rails that ran along ordinary streets—to get around in urban areas. On trolleys, there is a literal “free rider problem”: Since the trains were right next to sidewalks, and since trolleys were wide open and never had doors, people could hop on and off very easily. How much money will a trolley lose if it is easy to ride for free? If “free riders” are a big problem, what will happen to the supply of trolley rides? What are a few things the trolley industry could do to solve the problem of free riders?

Free riders in Jakarta, Indonesia
TATAN SYUFLANA/AP PHOTO

Question 7.23

3. During the Great Leap Forward, millions of Chinese starved to death because not enough food was produced by farmers. Why didn’t farmers grow food? In particular, was it because there wasn’t enough human capital or physical capital?

The slogan of the Great Leap Forward was “Long live the People’s Commune!” Unfortunately, this patriotic appeal didn’t work as well as good economic incentives, and millions lost their lives.
(Source: Wikipedia, “Great Leap Forward.”
THE IMAGE WORKS/©TOPFOTO

Question 7.24

4. Laws that encourage businesses to stay small are often very popular. The laws governing Indian shirt tailors discussed in this chapter are just one example. What are some noneconomic (e.g., social, moral, ethical) reasons why voters might want businesses to stay small? What are some economic reasons they might want businesses to grow large?

Question 7.25

5. Economists use the term “human capital” to refer to education and job skills. How is education like a piece of capital?

Question 7.26

6. Many people say that natural resources like oil and minerals are the way to prosperity. Indeed, in an old cartoon by Matt Groening, creator of The Simpsons, a professor taught his students, “The nation that controls magnesium controls the universe!” But natural resources have been left out of this chapter completely. Is this a big mistake? (Source: Sala-i-Martin, X., G. Doppelhofer, and R. Miller. 2004. Determinants of long-term economic growth: A Bayesian averaging of classical estimates (BACE). The American Economic Review 94(4) (September): 813–835.)

  1. Here are the 10 countries in the world that have the highest amounts of hydrocarbons (oil, natural gas, etc.) per person, in rank order:

    1. Kuwait

    2. United Arab Emirates (UAE)

    3. Saudi Arabia

    4. Iraq

    5. Norway

    6. Venezuela

    7. Oman

    8. Iran

    9. Trinidad and Tobago

    10. Gabon

    Use the CIA World Factbook, a convenient online source of information, to see if most of these countries are prosperous. How many of these 10 countries have a GDP per person that is at least half of the U.S. level? How many are less than 10% of the U.S. level? Are any actually higher than the U.S. level?

  2. Now, let’s look at the reverse: Let’s see if the 10 richest countries in GDP per capita have a lot of hydrocarbon wealth:

    1. Luxembourg

    2. United States

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    3. Singapore

    4. Hong Kong

    5. Norway

    6. Australia

    7. Sweden

    8. Canada

    9. Denmark

    10. Japan

The one country on both lists also makes another list in this chapter. Which one is it?

Question 7.27

7. Economists often refer to the “natural resource curse,” by which they mean that large amounts of natural resources tend to create bad politics because as long as the oil keeps flowing or the diamonds remain plentiful, political leaders don’t need to care much about what goes on in the rest of the country.

  1. Which one of the three factors of production do you think matters most to a leader of a resource-rich country? Why? (Note: Does this help explain what you see happening in many resource-rich countries?)

  2. Which one of the five key institutions do you think matters most to a leader of a resource-rich republic? Why? (Note: Does this help explain what you see happening in many resource-rich countries?)

Question 7.28

8. Let’s figure out how long it will take for the average Indian to be as wealthy as the average Western European is today. Note that all numbers are adjusted for inflation, so we’re measuring output in “piles of stuff,” not “piles of money.” India’s GDP per capita is $3,500, and (somewhat optimistically) let’s say that real output per person there grows at 4% per year. Using the rule of 70, how many years will it take for India to reach Italy’s current level of GDP per capita, about $28,000 per year?

Question 7.29

9. In the Soviet Union, especially in the early decades under Lenin and Stalin, the official doctrine was Communism, and the use of incentives was considered a form of treason. One important exception was the military equipment sector, where bonuses were common for engineers who designed and manufactured jets, nuclear missiles, tanks, and rifles. Why was this an exception?

Question 7.30

10. Free rider problems are everywhere. For example, some restaurants let each food server keep his or her own tips. Other restaurants require all of the food servers to put their tips into a tip pool, which then gets divided up equally among all of the servers. It’s easy to adjust the tip pool so that people who work more hours or serve more tables get their “fair share,” so that’s not the issue we’re concerned about here. Instead, let’s think about how the tip pool changes the server’s incentive to be nice to the customer.

  1. To keep it simple, let’s assume that a server can be “nice” and earn $100 in tips per shift, or be “mean” and earn $40 in tips per shift. If an individual server goes from being mean to being nice, how much more will he or she earn in a non-tip-pooling world? (Yes, this is an easy question.)

  2. Now let’s look at incentives in a tip pool. If all the servers are mean, how much will the average server earn? If all the servers are nice, how much will the average server earn? What’s the change in tips per server if all of them switch from being mean to being nice?

  3. But in the real world, of course, each server makes his or her own decision to be mean or nice. Suppose that some servers are being nice and others are being mean, and you’re trying to decide whether to be nice or mean. What’s the payoff to you if you switch your behavior? Does your answer depend on how many other servers are being nice?

  4. So when are you most likely to be nice: when you’re in a tip pool or when you keep your own tips? If the restaurant cares a lot about keeping its customers happy, which policy will it follow?

Question 7.31

11. If “everyone used to be poor,” then how could some ancient civilizations afford to create massive buildings like the pyramids of Egypt and the Buddhist statues of Afghanistan (sadly, many of the latter were destroyed by the Taliban in the 1990s)?

CHALLENGES

Question 7.32

1. One way to learn about what makes some countries richer is to run statistical tests to see which factors are good at predicting a nation’s level of productivity. Sometimes it turns out that a relationship is just a coincidence (like the fact that people in rich countries eat more ice cream), but other statistical tests really can tell you about the ultimate causes of productivity. A statistical test can’t tell you everything, but it might help point you in the right direction. In courses on econometrics and statistics, you can learn about how to run sensible tests.

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Let’s look at one well-known set of tests, to see if what you learned in this chapter matches the statistical evidence. Here are 17 variables that turned out to be very strong predictors of a nation’s long-run economic performance in literally millions of statistical tests (Source: Sala-i-Martin, X., G. Doppelhofer, and R. Miller. 2004. Determinants of long-term economic growth: A Bayesian averaging of classical estimates (BACE). The American Economic Review, 94 (4) (September): 813–835.) They are in rank order, and a “+” means more of that value was good for long-run productivity:

  1. Whether a country is in East Asia (+)

  2. Level of K−6 schooling (+)

  3. Price of capital goods (−)

  4. Fraction of land close to the coast (+)

  5. Fraction of population close to the coast (−)

  6. Malaria prevalence (−)

  7. Life expectancy (+)

  8. Fraction of population Confucian (+)

  9. Whether a country is in Africa (−)

  10. Whether a country is in Latin America (−)

  11. Fraction of GDP in mining industries (+)

  12. Whether a country was a Spanish colony (−)

  13. Years open to relatively free trade (+)

  14. Fraction of population Muslim (+)

  15. Fraction of population Buddhist (+)

  16. Number of languages widely spoken (−)

  17. Fraction of GDP spent on government purchases (−)

  1. Which of these factors sound like the “three factors of production”? Which ones do they sound like?

  2. Which of these factors sound like the “five key institutions”? Which ones do they sound like?

  3. Which of these factors sound like geography?

  4. The Western United States was a Spanish colony until 1849. On average, former Spanish colonies have had poor economic performance. Does the Western United States fit that pattern? Why or why not?

Question 7.33

2. What do you think creates the good institutions that exist in rich countries? Why don’t these institutions—property rights, markets, a society where you can usually trust strangers—exist everywhere on the planet?

Question 7.34

3. Why do you think expensive red tape is difficult to get rid of in many poor countries? Yes, this is a miniature version of the previous question.

Question 7.35

4. Communists believed that their system would be much more efficient than capitalism: They thought that competition between companies was wasteful. Why build three separate headquarters for carmakers (General Motors, Chrysler, and Ford), when you can just build one? Why have three advertising budgets? Why pay for three CEOs? Why not put all the factories together, so that the same engineers can fix problems at all of the plants? Doesn’t one large firm maximize economies of scale? These are all good questions. So why do you think Communism turned out to be such an economic disaster, when it sounded like it would be so efficient?

Question 7.36

5. The chapter lists five key institutions of economic growth. But isn’t there really just one: good government? Support your argument with facts from this chapter.

Question 7.37

6. Figure 7.5 and its discussion in the text identify some of the ultimate causes of the Wealth of Nations as Institutions of Economic Growth. One of these is honest government. Go to Gapminder at http://www.gapminder.org to explore this relationship. Once there, click on the tab for “Gapminder World” and wait a moment for the first graph to load. Once it has loaded, click on the axes and explore the number of variables available for choosing. For this problem, click on the vertical axis, look under “Society,” and choose the “Corruption Perceptions Index (CPI).” You should still have GDP per capita on the horizontal axis.

  1. After noting that higher values in the CPI represent lower levels of corruption, describe what these data are telling you.

  2. Next to the upper right-hand corner of the diagram is a “Color” box. Click on it and set it to “Geographic regions.” Now hover over a color and explore where these regions are in the world. Where are the richest countries? Where are the poorest?

  3. Can you find some very corrupt countries that are also quite rich? Name some of these countries and determine what they have in common.

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  4. Does this evidence generally support the claim that an honest government contributes to the wealth of a nation? Why or why not?

Question 7.38

7. Figure 7.5 and its discussion in the text identify one of the immediate causes of the wealth of nations as human capital. Visit Gapminder World again at Gapminder http://www.gapminder.org and select “Education” and “Literacy Rate, Adult Total” for the vertical axis while leaving GDP per capita on the horizontal axis. (See the previous problem for more detailed instructions.)

  1. What does this display of data convey to you about the value of education?

  2. Now change the vertical axis to the “Mean Number of Years in School” for men and then create a second graph for women older than age 25. How do your conclusions change? Is education still as valuable?

  3. Finally, select eighth-grade math achievement for the vertical axis and determine if this measure of education is also positively associated with GDP per capita.

  4. How do these measures of education work to support or refute the relationship between education levels and GDP per capita?

  5. Now try an additional educational measure using two graphs. Under “Schooling Cost,” explore “Expenditures per Student, Primary” and “Expenditures per Student, Secondary.” What do you find in these cases and how can you explain these differences?

!launch! WORK IT OUT

Let’s figure out how long it will take for the average Indian to be as wealthy as the average Western European is today. Note that all numbers are adjusted for inflation, so we’re measuring output in “piles of stuff,” not “piles of money.” India’s GDP per capita is $3,500, and (somewhat optimistically) let’s say that real output per person there grows at 5% per year. Using the rule of 70, how many years will it take for India to reach Italy’s current level of GDP per capita, about $28,000 per year?

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