Use the production function approach to examine Bolivia and Chile. Assume that Bolivia and Chile have different production functions, q = f(k) , where q is output per worker and k is capital per worker. Assume that A in Bolivia is lower than A in Chile.

a. Draw a production function diagram (with output, q, as a function of capital, k) and MPK diagram (MPK vs. k) for Chile.

b. On the same diagrams, plot Bolivia’s production function and MPK curves, assuming that Bolivia’s MPK currently exceeds Chile’s MPK. Label Chile’s position in each graph point A. Similarly, label Bolivia’s position point B.

c. Assume that capital is free to flow between Chile and Bolivia (and the rest of the world) and that Chile is already at the point where MPK = r^*. Label r^* on the vertical axis of the MPK diagram. Assume no risk premium. Where does Bolivia’s capital converge? Label this outcome point C in each diagram. Will Bolivia’s level of output per worker converge with that of Chile’s? Explain why or why not.

d. How would the existence of a risk premium (required by investors for Bolivian capital investment projects) affect your answer to (c)? 

e. Describe two government policies that Bolivia could implement to improve the convergence process.