Econ 242 Problem Set 1

Prof. Gustavo Ventura. Due date: February 1st., 2005. 1. Let F (K, AL) be a production function with constant returns to scale. F and Suppose labor and capital are paid their marginal products, AL F . Let w be the rental price for labor services and R the rental rate K of capital. (a) Show that F (K, AL) = wAL + RK . (b) Show that along a balanced growth path: i) labor income perworker ( wAL ), grows at the rate of technical change g ; ii) labors L , is constant. share in income, wAL Y (c) Suppose the economy starts with k (0) < k . Describe qualitatively the time path of w implied by the Solow model. 2. Consider the C.E.S. (Constant Elasticity of Substitution) production function: F (K, AL) = [a(K ) + (1 a)(AL) ]
1/

with a (0, 1) and < 1. This production function displays constant elasticity of substitution between capital and labor equal to 1/(1 ). (a) Show that the CES production function displays constant returns to scale. Obtain the production function in intensive form, f (k ).

(b) Obtain f (k ). Show that, for the cases < 0 and 0 < < 1, the Inada conditions are not satised. 3. Problem 1.5 in Romer. 4. Suppose the production function is Cobb Douglas: Y = K (AL)1 . (a) Suppose k (0) < k . Show that the Solow model implies that the capital to output ratio (K/Y ) is increasing over time. (b) Denote the capital to output ratio as v (t). Show that the fundamental dierential equation of the Solow model can be written as v + (1 ) (g + n + ) v (t) = s(1 ) (c) What is the exact solution for the time path of the capital to output ratio v (t) ? 5. Consider a Solow growth model with Cobb-Douglas production function: Y = K (AL)1 . (a) Derive the equation that governs the dynamics of the growth rate of output per eective worker, y (t)/y (t). (b) Argue that the growth rate for y (t) declines over time if y (0) < y . (c) Consider an economy along a balanced growth path described by the following parameters: = 0.06, n = 0.012, g = 0.018 and = 0.36. Find the saving rate so that, along the balanced growth path, the capital to output ratio equals 3.0.1 What is the instantaneous impact upon y (t)/y (t) of a ten percent increase in the saving rate? 6. Consider the dynamics of capital accumulation in an economy in which households save a constant fraction of their income (Solow model). Households are endowed with one unit of productive time, of which all of them devote a xed fraction h to work. Population grows at the rate n, and the total size of the population at time t is M (t). Output is produced through a constant returns to scale technology that requires both capital and labor. Finally, suppose for simplicity that the rate of technical change and the depreciation rate are both zero.
1

These values are consistent with U.S data.

(a) Derive the dierential equation that governs the dynamics of capital to labor ratio. (b) Analyze qualitatively the dynamic eects on capital to labor ratio of a sudden and permanent increase in the fraction of time devoted to work, h. Suppose labor is paid its marginal product. Describe the dynamics of the wage rate following the increase in h. Is output per-capita higher in the new steady state?