A Theoretical Growth Model for Ireland

A THEORETICAL GROWTH MODEL FOR IRELAND

This expression differs from Equation (6) only due to the first term on the
right hand side, which is positive, and captures the monopoly union distortion.
Since this term pushes up the required wage for each level of €1, conditional
on w₂, the distorted labour supply schedule lies to the left of the undistorted
schedule. Without loss of generality, we then write the labour supply curve for
the domestic economy as:

€1 = €( w 1)Θ,                                    (8)

where € '(w 1) > 0, and Θ captures all other elements that affect labour supply.
In particular, a fall in the monopoly union distortion in the home economy
would imply a rise in Θ.¹²

Domestic Firms

Firms in the home economy hire labour and accumulate capital. The firm’s
instantaneous production function is written as

Y= AF(K, L).

We assume that F(K, L) has constant returns to scale in capital and labour,
and A captures a total factor productivity shift variable.

The firm may purchase capital at price q, and hires labour at the home
wage w₁. The firm’s capital stock depreciates at instantaneous rate δ. The firm
will hire labour and purchase capital to satisfy

AFL(K, L) = w1                           (9)

( r + δ) q = AFk(K, L ) + q.                       (10)

The second condition simply says that the return on a unit of capital
should equal its opportunity cost, where r is the cost of external borrowing.

Aggregate Capital Accumulation

We assume that there are convex costs of capital installation (or
adjustment costs) in the home economy. The implication of adjustment costs is
that there will be a relationship between aggregate investment and the price

¹²In referring to the term Θ as a ‘distortion’, even though it arises from a trade union maximising
utility, our terminology is in line with the usual description of monopoly pricing distortions. In
particular, employment is below its socially efficient level due to the presence of the Θ term.

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