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Macroeconomics I

Problem Set # 4

Question 1. Both country A and country B have the following production function:
Y F ( K , L) K 1/ 2 L1/ 2 .
a) What is the per-worker production function, y=f(k)?
b) Assume that neither country experiences population growth (nor technological
progress) and that 5 percent of capital depreciates each year. Assume further that
country A saves 10 percent of output each year and country B saves 20 percent of
output each year. Find the steady-state level of the following variables for each
country:
(i) Capital per worker.
(ii) Income per worker.
(iii) Consumption per worker.
c) Suppose both countries start off (period t = 1) with the same stock of capital per
worker, equal to 2. Calculate the consumption and capital stock for each country in
periods t = 1, 2 and 3. In which country consumption per capita is higher in these
periods? And in steady state?
Question 2. Consider the Solow model with production function f(k)=Ak1/2, s=0.10,
A=10, and n==1/8. Given an initial capital stock K=1,000,000 and an initial
population L=1,000,000, find:
a) The equilibrium values of capital per worker, income per worker, and consumption
per worker for periods 0, 1, 2 and 3.
b) The steady state values for the same three variables.
c) In the long run (steady state), what is the growth rate of RGDP? And the growth rate
of aggregate real Consumption?
d) In the initial periods, is the growth rate of RGDP higher of lower than in steady state?
And the growth rate of per capita RGDP?

Question 3. Solow with government. Let us introduce three modifications in the


Solow model. Suppose the consumption function is given by
ct (1 s ) (1 ) yt
where 0<<1 is the income tax rate, and 0<s<1 is the marginal propensity to save.
Suppose the investment function is given by
I t Lt invt Lt inv(rt )
where inv(rt) denotes investment per capita and is a decreasing function of the real
interest rate. Finally, let public consumption and taxes be given by
Tt Yt ,
Gt Yt ,
0 , 1.
a) Define the savings of the public sector. For what values of and is there a fiscal
deficit? And a surplus?
b) Find an expression for national savings (private plus public) that only depends on
population, the capital-labor ratio, and exogenous variables (constants).
c) Let s denote the expression with all the constants, which can be interpreted as the
savings rate of the economy. What happens to s when public spending () increases?
And when taxes () increase? Now suppose that ==. When increases, what
happens to s?
d) Consider period t=2008. Suppose k(2008)=4. Suppose also that the production
function is Cobb-Douglas and CRS, with the exponent on capital equal to 0.5, and
that the per capita investment function is inv(r)=1-0.10r. Find the equilibrium real
interest rate for 2008.
e) Suppose that the steady state capital-labor ratio is k*=5. Between years 2008 and
2200, will the interest rate increase or decrease?
Question 4. Consider the production function Y = 8 K1/2L1/2, capital depreciation of
40%, population growth of 10% and savings rate of 40%. Find:
a) The steady-state values of both capital and income per worker.
b) The golden rule values of both capital and income per worker.
c) The savings rate associated to the maximum consumption.
d) The increase in consumption from the steady state to the golden rule.
e) Could you say that consumption increases in a sustained way when we apply the new
savings rate?
Question 5. Consider the production function Y = 5 K1/2L1/2, capital depreciation of
20%, population growth of 20% and savings rate of 60%. Find:
a) The steady-state values of both capital and income per worker.
b) The savings rate associated to the maximum consumption.
c) The golden rule values of both capital and income per worker.
d) The increase in consumption from the steady state to the golden rule.

Question 6. Consider the production function Y = 8 K1/2L1/2, capital depreciation of


40%, population growth of 2% and savings rate of 40%. Find:
a) The steady-state values of both capital and income per worker.
b) The golden rule values of both capital and income per worker.
c) The savings rate associated to the maximum consumption.
d) The increase in consumption from the steady state to the golden rule.
e) Could you say that consumption increases in a sustained way when we apply the new
savings rate?

Question 7. Consider an economy without population growth. The production function


in per capita terms is y = 7k1/2. The yearly capital depreciation is 14 %. Households
consume the 90% of their income. Find:
a) The savings rate associated to the maximum consumption
b) The increase in consumption from the steady state to the golden rule.
Question 8. Consider the production function Y = K1/2L1/2, capital depreciation of 7%,
population growth of 3% and savings rate of 40%. Find
a) The steady-state values of consumption, capital and income per worker.
b) The steady-state values of consumption, capital and income per worker if the
population growth is 1%.

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