CFA CFA Level 1 Labor, capital and technology

# Labor, capital and technology

• This topic has 11 replies, 5 voices, and was last updated Feb-2410:41 am by ajost14.
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This comes from the Schweser Q-Bank, I’m not sure I understand their rationale. How do the percentages they present you with in this question factor into figuring out how to answer the question? Below is the question and the rationale.

Consider an economy in which laborâ€™s relative share of national income is 60%. For which of the following sources of economic growth will a 1% increase result in the largest increase in potential GDP?

A) Labor.

B) Capital.

C) Technology.

The answer is C, technology.

The contributions of technology, labor, and capital to potential GDP can be modeled as follows: Growth in potential GDP = growth in technology + WL(growth in labor) + WC(growth in capital), where WL is laborâ€™s relative share of national income, WC is capitalâ€™s relative share of national income, and WL + WC =1.

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And as you can see, @MattJuniper beat me to it!

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Technology, then, would always have a larger impact on potential growth to GDP than either labor or capital alone? I guess that concept is what threw me off, that and all the percentages being thrown around, haha.

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You’re very welcome!

Without getting too much into it, as I fear that my subpar teaching skills might confuse you, the basic premise is this:

GDP is a function of labor, capital, and technology.

Technological progress enhances the productivity of both capital and labor.

As is such, technology has a larger impact on potential GDP growth than either labor or capital alone.

@ajost14

• Snippy
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• CFA Level 2
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@MattJuniper I worked it out too a couple of days back ðŸ˜›

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@diya I think I just worked out what your special Snr PM ability is ðŸ˜‰

@MattyJ
It took me awhile to figure out all my special abilities. I have more :p

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@diya I think I just worked out what your special Snr PM ability is ðŸ˜‰

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This is straight forward to see if you substitute 1% in for each of the three growth variables (technology, labour and capital) whilst holding the other two factors at 0 (and thus seeing the exact amount of effect each has on GDP). The question states that WL = 0.6, and so WC = 1 – 0.6 = 0.4.

So, given the above, the equation gan be rewritten as follows:

Growth in GDP = (growth in technology) + (0.6)(growth in labour) + (0.4)(growth in capital)

Scenario 1: Tech Growth = 1%, Labour Growth = 0%, Capital Growth = 0%
Growth in GDP = (1%) + (0.6)(0%) + (0.4)(0%) = 1%

Scenario 2: Tech Growth = 0%, Labour Growth = 1%, Capital Growth = 0%
Growth in GDP = (0%) + (0.6)(1%) + (0.4)(0%) = 0.6%

Scenario 3: Tech Growth = 0%, Labour Growth = 0%, Capital Growth = 1%
Growth in GDP = (0%) + (0.6)(0%) + (0.4)(1%) = 0.4%

So you can see that a 1% increase in technology has a bigger impact than a 1% increase in either labour or capital, and this is due to the weighting factors for bothe being less than 1.

Hope that makes sense!

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If I’m looking at it right, it should simply be due to the fact that the full % of technology growth would contribute to “Growth in potential GDP.”

So for example, if you were to increase each factor by 1%

Technology would contribute 1% to potential GDP
Labor growth would contribute 1% x 60% = 0.60% to potential GDP
Capital growth would contribute 1% x 40% = 0.40% to potential GDP

As you can see, if you were to increase any of these sources of economic growth by 1%, technology will contribute the the most to potential GDP.

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@dollarstodonuts but your answer was more efficient ðŸ˜€

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I suppose you could have a hypothetical scenario where WL was 1 and WC was 0 and theme there would be two possible answers…:D

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Fair enough. Thanks for explaining @MattJuniper and @DollarsToDonuts!