ADVANCED MACROECONOMICS

Part 2 Problem Set 2

QUESTION 1
Consider a representative household which can accumulate capital, and which chooses
the path of consumption to maximize lifetime utility:
Z
c(t)1 t
max e dt
c(t) t=0 1

subject to a capital accumulation (resource) constraint. c denotes consumption per

capita, and is the discount rate. Use to denote the depreciation rate. You should
assume the production function has constant returns to scale and can be written in in-
tensive form as y = f (k), where y Y /AL, k K/AL, K is capital, A is efficiency,
and L is labour. The level of efficiency grows at a constant rate x, so A(t) = A(0)ext .
Assume A(0) = 1. The population is constant, and > 0, > 0 and 0 < < 1.
a) Defining c c/A, explain why k = f (k) c (x + )k.
b) Rewrite the maximization problem in terms of k and c = cext .
c) Using a Hamiltonian, derive the growth rate of consumption per capita.
d) Briefly discuss whether a restriction on is needed for the problem to be well-
defined.
QUESTION 2
This question allows population growth, and assumes that all households receive a
foreign aid transfer. There is no technical progress. Consider a representative household
which chooses the path of consumption to maximize the total utility of the household:
Z
c(t)1
max L(t)et dt
c(t) t=0 1

subject to a capital accumulation constraint. The population L(t) is growing at a con-

stant rate n, so L(t) = L(0)ent . c denotes consumption per capita. Use D to denote
total aid flows, which grow at the same rate as population, and are distributed equally
across households. is the discount rate, and is the depreciation rate. You should
assume the production function has constant returns to scale and can be written in in-
tensive form as y = f (k), where y Y /L, k K/L and K is capital. You should
assume > 0, > 0 and 0 < < 1.
a) Explain why k = f (k) + d c (n + )k where k K/L and d D/L.
b) Using a Hamiltonian, derive the growth rate of consumption per capita.
c) Show that the steady-state k is independent of the level of aid.
d) Discuss whether the result obtained in part c) indicates that aid is ineffective.

END OF PROBLEM SET