Use production function and MPK diagrams to examine Turkey and the EU. Assume that Turkey and the EU have different production functions q = f(k) where q is output per worker and k is capital per worker. Let q = Ak1/3. Assume that the productivity level A in Turkey is lower than A in the EU.
a. Draw a production function diagram (with output per worker y as a function of capital per worker k) and MPK diagram (MPK versus k) for the EU.
b. For now, assume capital cannot flow freely in and out of Turkey. On the same diagrams, plot Turkish production function and MPK curves, assuming that the productivity level A in Turkey is half the EU level and that Turkish MPK exceeds EU MPK. Label the EU position in each chart EU and the label the Turkish position T1.
c. Assume capital can now flow freely between Turkey and the EU and the rest of the world and that EU is already at the point where MPK = r*. Label r* on the vertical axis of the MPK diagram. Assume no risk premium. What will Turkey’s capital per worker level k be? Label this outcome point T2 in each diagram. Will Turkey converge to the EU level of q? Explain.