C5109: Macroeconomic theory and policy Assignment 2 ‘The Ramsey-Cass-Koopmans model assumes that government purchases do not affect utility from private consumption. However, the opposite view is that government purchases and private consumption are perfect substitutes. Suppose that the modified utility function in the Ramsey-Cass-Koopmans model is given by +0 feeornp-? u=8f oe ae. Where B = A(0)'~°L(0)/H and B = p—n-(1—8)g. If households’ preferences are given by U and if the economy is initially on its balanced growth pat, what are the effects of a temporary increase in government purchases on the paths of consumption, capital, and the interest rate? [25] 2. Inthe class of learning by doing models, suppose that output at firm i is given by ¥, = KL}-(K®L~*). Here K; and L; are the amounts of capital and labour used by the firm; Kand L ar ethe aggregate amounts of capital and labour; and a > 0, > 0, and 1 > a + @ > 0, Assume that factors are paid their private marginal products; thus r; = 224 assume that the dynamics of K and L are given by K = s¥ and L = nL, and that K;/L; is the same for all firms. (i) Derive r as a function of K/L. [10] (ii) Whatis K/L on the balanced growth path? What is r on the balanced growth (8) \crease in domestic saving raises domestic investment, positive externalities from capital would mitigate the decline in the private marginal product of capital. Thus the combination of positive externalities from capital and moderate barriers to capital mobility may be the source of Feldstein and Horioka (1980) findings that saving and investment rates are strongly correlated”. Does your analysis in parts (i) and (ii) support this claim? Explain intuitively. 7) (iii)Hints. Assignment 2 ee 5109 a4 ke £0e)-¢-4 -G4g)k Geol purchases per muh 0 effective Gb “Hans clees thie change HIS Sphaizahin 2 Irasad of 2 Glakle & ? e* 4G é, Tren, i € Analyze Using the phase dingrem - A. k 2 a Ge wet ce] what re) and occ n Ve, bine Kcf., 18 Same memes ast fiems and te preduckion furchen Rat CRE the AGGregate posda fo is Xd 6" Yee rec], Wet Clete orepnt Per perker 2 Taking Kare deniahve. ot R= £, denve tke pial actamulaioa egressen ancl Crlenlak Ke Heady thle, and Me Marginal pedack Of Gpilnl om fe balanced g7evte parr iz see whether > affects RE Aady-shte ralas of Ke Marginal pranct of Gpil, ad or disuses ke eloremic intechen, ta rebel,