Question

Federal Reserve Bank of St. Louis Page One Economics®: “Why Are Some Countries Rich and Others Poor?”

After reading the article, complete the following:

1. Why is GDP per capita used as an estimate of the average standard of living in a country?

2. Why is economic growth key for countries who want to escape poverty?

3. How do institutions increase total factor productivity (TFP) and create incentives for economic growth?

4. The “institutional theory” suggests that by establishing property rights, free and open markets, and the rule of law, a country will create the incentives necessary for markets to develop and the economy to grow without much other government intervention. Describe how evidence from South Korea and China suggests that, in some cases, government must play a larger role.

5. How can international trade increase TFP within a country?

Answer 1

1. GDP per capita is used as an estimate of the average standard of living in a country because GDP is the sum of the value of all the goods and services produced within the economy in the given year. It is the yearly income of a country. When divided by its population,the GDP per capita gives the value of output a person produce(and hence spend). So,it is a measure of average standard of living.

2. Since GDP is the measure of income of the country and to escape poverty it is important to rise incomes, economic growth (rise in the GDP of the country) becomes important for poverty reduction.

3. Institutions provide the set of environment the business/producers of goods and services reside in. When the rights of the producers are backed by institutions, property rights are well defined and free markets are provided, it incentivises the producers to produce more goods and services. As production increases, economic growth follows.

Total factor productivity increases due to the investment in skill development and technology. Investment takes place because the producers are motivated by the fact that they will be monetarily rewarded. Property rights and law enforcement institutions play major role in ensuring the reward.

4. In South Korea and China,the economic growth kickstarted with government-led initiatives. The south Korean government, under the dictatorial rule of Park Chung-hee , in 1960s focused on industrialization and export driver industry. In China also, under Deng Xiaoping in 1978, the government led initiatives of industrialization and development of markets internal and for exports, led the path for economic growth in China.

5. When countries participate in international trade,they can access capital goods (from advanced nations) and increase their total factor productivity.