S(,LU

UNS'I'O CHAPTER I

ltoblem 1.1 (e) Since growthrateof a variable the equals time derivative its log, as shownby equatim(1.10) the of

fre texf,, canwrite we .,, 2$) dlnz(t) d h[x(t)Y(t)] tl, ' - = -= z(t) dt dt since logoftheproduct the oftwo variables equals sum the oftheirlogs, have we ,-, Z(t) a[mx1t)+lnY(t)] dhx(t) dlny(t) = "' z(t\ dt dt ' a siryly Ztq x(t) Yttl --*

rt)

* 40= x(,) y(r)

(b) Again, since the growth rate of a variable equalsthe time derivative of its log, we can write

'*' 4t)= dt dt Sincethe log of the ratio of two variables equals difference their logs,we have the in dhX(t) dlny(t) ,., 2(t) a[nx1t;-lny(t)]

,,, Z(t) dtnz(t) amlxAl/vttl] =

=

t-'tV5=
r sinply
t0t -=-

d,

&

d,

'

Z$) x(t) V(t) z(t) x(t) Y(t)

(c) We have ,^ 2$)

dt dt '" z(t) Using factthatln[X(t)" ] = alnX(t),wehave the dhx(t) x(t) ,-;, -z(t) d[crhx(t)] =u,-=q. tO z(t) dt dt x(t)'
nfiere we have used the fact that cr is a constant.

dlnz(t)

dln[X(t)c]

Problem1.2 [a) Usingthe informationprovidedin the question, the grorvth rateof X, X(t)/X(t), is depicted oathofthe in he figure at right. Fromtime 0 to time t1 , the growth rateof X is constant nd equalto a > 0. At time t1 , the growthrateof X lrops to 0. Fromtime tr to time t2 , the growth rate of K risesgradually from 0 to a. Notethat we havemade he assumption Xttl/Xttl risesat a constant that rate homtl totz. Finally, aftertime rateof b,thegrowth K is constant equal a again. and to

Solutions Chaper 1 to

(b) Notethatthe slo,pe InX(t) plded againsttime of is equalto the growth rate of X(t). That is, we knotrr dlnX(t) X(t) = dt x(t) (See (l:10) inthetext.) equation Fromtime 0 to time tr the slo'pe lnX(t) equals of a > 0. The lnx(t) locushasan inflectionpoint at t1 , whenthe gfowth rate of X(t) sfornges discontinuously from a to 0. Between andtz, the slope lnX(t) tr of risesgraduallyfrom 0 to a. After time tz the slopeof lnx(t) is constant equalto a > 0 again. and Problem 1.3 (a) The slopeofthe break-even invesEnera is line given by (n + g + 6) andthus a fall in the rateof depreci*ion,6, decreases slopeofthe break-even the investment line. The actual investment curve,sf(k) is unaffected. Fromthe figure at right we cansee that the balancedgrowth-pathlevel of capitalper unit of effectivelabor risesfrom k* to k*mw .

(b) Since the slope ofthe break-eveninvestment line is given by (n + g + 6), a rise in the rate of technological progress, g, makesthe break-even investrnent line steeper. The actual investrnent curye, sf(k), is unaffected. From the figure at right we can seethat the balancedgrowth-path level of capital per unit of effective labor falls from k* to k*Nrw .

(n+ gqE w + 6

Solutions Chapter1 to

(c) The break-eve,n investment line, (n + g + 6)k, is unaffected bythe risein capital's share, c. The effectof a change c on the actualinvestment in curve,sko,canbe determined examining by the (n+g+6)k derivativeAGk"yAd. It is possible showthat to &ktr ( l) =sk*lnk. ^ (n" For 0 < ct ( l, andfor positivevalues k, the sign of of d(sk")/dais determined bythe signof Ink. For lnk > 0, or k > l, 1sko fu"> 0 andsothenewactual f investment curvelies abovethe old one. For fnk < 0 ork < l, Ask" fu.<0 andsothenewactual investment curveliesbelowthe f oldone. Atk= l, that Ink: 0, thenewactualinvestment curveintersects old one, the In addition,the effectof a rise in cr on k* is ambiguous depends the relativemagnitudes s and and on of (n +g + 6). It is possibletoshowthata risein capital's share, will causek*to riseif s > (n + g + 6). cr, This is the case depicted the figureabove, in (d) Suppose modify the intensive we form of the productionfimctionto includea non-negative constant, sothat the actualinvestment B, curveis givenby sBf(k),B > 0. Thenworkersexertingmoreeffort, sothat ouQutper unit of effectivelabor is higherthan before,canbe modeled an increase B. This increase B as in in shiftsthe actualinvestment curyeup. The break-even investment line, (n + g + 6)k, is unaffected. Fromthe figure at right we can seethat the balanced-growth-path of capital per unit of effectivelabor level risesfrom k* to k*NEw . Problem1.4 (a) At some time, call itto, fhereis a discreteupwardjumpin thenumberof workers. This reduces the amout of capitalper unit of effectivelaborfrom k* to ksq, . We canseethis by simply lookingat the definition, IVAL. An increase Lwithouta jump in K or A causes k: in ktofall. Sincef'(k) > 0,this fall in &e amountof capitalper unit of effectivelabor reduces amountof outputper unit of effective the laboraswell. In the figurebelow,y falls from y* to y*ew.

Solutions Chapter1 to

(b) Now atthis lower kNEv/ acf,ual , investment unit of effectivelabor per exceeds investment per break-even unit of effectivelabor. That is, sf(krnuw > G + 6)kNow The . ) economy now savingandinvesting is morethan enough offset to depreciation technological and progress this lower kyByy Thusk at . begins risingbacktowardk*. As capitalper unit of effectivelabor beginsrising, so doesoutputper unit of effectivelabor. That is, y begins rising from ywew backtoward f .

v = f(k) 19+ 6)k

k=K/AL

(c) Capitalper unit of effectivelaborwill continue riseuntil it eventuallyretumsto the original level of to k*. At k*, investment unit of effectivelabor is againjust enough offsettechnological per progress to and depreciation keepk constant. Sincek returns its originalvalueof kt oncethe economy and to againretums growthpath, ouQutper unit of effectivelabor alsoretumsto its original valueof to a balanced y* = f(k*). Problem1.5 (a) The equation describing evolutionof the capitalstockper unit of effectivelabor is givenby the (1) k = sf(k) - (n +g +6)k, Substituting for the intsrsiveform of the Cobb-Douglas, = k", yrelds in f(k) k=skd -(n+g+6)k. growthpa&, k is zero;investment unit of effectivelabor is equalto break-even On the balanced per investment unit of effectivelabor andso k remains per constant.Denoting balanced-growthaath the value of k ask*, we havesk*": (n * g + 5)k*. Rearranging solvefor k* yields to (2) k* = [s/(n+g +o;]l/(l-ct). To getthe balanced-growth-path valueof outputper unit of effectivelabor, substituteequation into the (2) intensive form of the productionfirnction,y: ko: (3) y* = [s/(n+e +61]c/(t-oi. per Consumption unit of effective laboronthebalanced growthpathis givenby c* = (1 - s)yt. (3) Substitutingequation into this expression yields (4) c* = (l- s)[s/(n +oy]d/(t-ul, +g levelof the capitalstockis that leve!at which consumption unit of per O) Bv definition,the golden-rule effectivelabor is maximized.To derivethis levelof k, take equation which expresses balanced(2), the growth-pathlevelof k, andrearrange to solvefor s: it ( 5) s=( n+g+6)kt1-4. (5) Now substitute (4): equation into equation tt*' = (n +g +6)k ".1--{,][(n +g+6)k * l-a / t n * * * u r, " [t"* After somestraigbtforward algebraic manipulation, srmplifies this to

1 to Solutions Chapter

( 6) c* =k* o- ( n +g+6)k*. laboris equal outputper uut to (6) per Equation canbeeasilyinterprded.Consumption unit of effective growthpath which on the balanced per of effectivelabor, k*o, lessactualinvestment unit of effectivelabor, is the sameas break-even per investment unit of effectivelabor, (n + g + 5)k*. (6) Now useequation to maximizec* wrth respect k*. The first-orderconditionis givenby to *o-l -(n + g + 6)= 0, 6"* I 6k* = crk or simply ( 7) o k* "- t:( n* g+6). Notethatequation(7)isjustaspecificformoff'(k*)=(n+g+5),whichisthegeneralconditionthat mplicitly defines golden-rule the levelof capitalper unit of effectivelabor. Equation(7) hasa graphical form of the productionfrurctionis mterpretation: defines levelof k at whichthe slopeofthe intensive it the equalto the slopeofthe break-even investment line. Solvingequation(7) for the golden-rule levelof k yields r8) k *6s = [a/(n +e +5;]r/(t-ai. equation(8) into (5): levelof k, substitute tc) To getthe savingratethat wrll yreldthe golden-rule scR= (n + g +s)[a/(n + g +o;](l-")lo-.,), whichsimplifies to
t 9l Sq 1 :cf.

sl-rtha Cobb-Douglas to productionfi.nction,the savingraterequired reachthe goldenrule is equalto the dasrcrty of outputwith respect capitalor capital'ssharein output (if capital eamsits marginalproduci) to Froblem1.6 progress, cancarry out the entireanalysisin termsof capitaland uu Since we thereis no technological they behave rr.ryu per worker ratherthan capitalandoutputper unit of effectivelabor. With A constant,

It'e ftll n the population growth rate makesthe lr:akev'en investment line flatter. In the msmce of technologicalprogress,the per unit ::n:e changein k, capital per worker, is given by x;= sfik)-(6+n)k. Sincek was 0 beforethe up,[rease n -- the economywas on a balanced rn g:--Jr path -- the decrease n causesk to in rwirffrnepositive, At k*, actual investmentper nurnrker. sf(k*), now exceedsbreak-even * rrr,Esffilntper worker, (nr,lew 6)k*. Thus k r,tr,il3r4;LEs higher balancedgrowth path to a new Lffirr;Er the figure at right. see r&id :ies. ) - output per worker -- also rises. 3 $rilrr,tri cnstant fraction of output is saved,c -per rflDrr$lnuncn worker -- rises as y rises. This nthe figures below. s nunrmanzed

(n + 6)ki

Solutionsto Chapter I

(b) By definition,ouput can bewritten as Thusthegrowthrateof ouput is I =!t. YIY =L/L+itly. Ontheinitialbalanced growth path, yly 0 - outputper worker is _ constant so Y/V =Llt= n. Onthe final balanced growth path,9ly = 0 again- outputperworker is constant again- andso tfV = Lft =nNEw < n. In the end,outputwill begrowingat a permanently lowerrate.

what happens duringthetransition?Examine production the fi:nctiony = F(K,AL). on the initial balanced growthpathAL, K andthusYareall gro*iog ;;. Thensuddenly begins AL growingat some newIowerrate "t suddenly Ywill bu6;;",1o-. ratebetween of K (whichis iqy: -T': that growingat n) andthat of AL (which is growing r;*t. if; luring the transition,ourputgrowsmore rapidly than it will on tle new balanceigrowth " path, but lessrapidlythan it would have without the decrease populatior growth es outpit g.o*a in graduallyrrooi, aor* duringthe transition, . so does capitalgrouth unt' finaty K, AL, andthuJy area' growingat the new lower nysw. Problem1.? The derirrative f = f(kr) with respect of to n is given by Q) df /A1: f 'ft+)[6k*/dnJ. Jo find dk*/al, usethe equationfor the evolutionof the capitalstockper unit of effective k=sf(k)-(n+g+6)k' Inaddition,usethefbctthaton"brl*""dgro,,rrthpath, labor, k--0,k:k*andtlus t*1,^: 5)k* Takinsthe derivativeof both sides of this expression with respecr n yields to I ;f-. sf'(k*):-(n +'g*d)--+ft +, An and rearranging yields an sf'(k*; - (n +g + 6) Substituting equation into equation givesus (2) (l)
Q) -=

a k*

k*

,t)#=r'(k*)L )k* sf'1 k* -(n+g+6)

Rearranging condition the that implicitly defines sf(k*) : (n * g + 6)k*, and solvingfor s yrelds k*, (4) s : (n + g + 6)k*/f(k*). (4) Substitute equation into equation(3): ay *'< f'(k*)k * (5) -=

ar

*/f1 +g [ ( n + g + 6 ) f ' ( k*)k t<*;1 -(n +E )'

To tum this into the elasticitythat we want, multiply both sidesof equation(5) by n/y*: n d y *= o f'(k*)krlf(k*) y * 0 n ( n +g +0 ) [f' (k*)k*/f(k*)]-l Usingthe definitionthat as (k*) = f '(k*)\t(k*) givesus n &* n I g-(k*), | \\
t a\ -. | I

y* A

( n+g +6 ) [l-crr(k*)_l

Now, with crx(k*) : ll3, g = 2o/o 6 = 3Yo, needto calculate effecton y+ of a fall in n from}%o and we the to |Yo. usingthemidpoint n = 0.015to calculaG elasticity of givesus the

= in the levelof outputper unit of effective labor,since(-0.50X-0,12) 0.06. This calculation illustrates tl point that observed differences populationgrowth ratesacrosscountriesarenot near$ enough in to accountfor differences y that we see. in

(ttz) nry* o. o t 5 =(olls* [1- *i=-o'tz / a' 'tr/*0o3) Sothis 50% drop in thepopulationgrowthrate,from Zo/oto1%,will leadto approximately 6o/oincrea a

Problem1.8 (a) A permanent increase the fraction of outputthat is devoted investment in to from 0.15 to 0.I 8 represents 20%o a increase the savingrate. From equation .27) in the text, the elasticityof outputwid in (l respect the saving to rateis a r ( k* ) s ay* /,\ I r , -y* 0 s l- cr 6 ( kx;' wherectx (k*) is the shareof incomepaidto capital (assuming capitatis paid its marginalproduct). that Substituting assumption or (k*) : 1/3into equation givesus the that (l)

s dy*= o K( ry)

y * 6 s 1- cr s( k* ) l-ll3 2 Thus&eelasticityofoutputwithrespecttothesavingrateis Sothis2}%increaseinthesavingra l/2. -- from s : 0.15to smw= 0.18- will cause outputto riserelative what it wouldhavebeen about to by 10%. [Notethatthe afialysis been has carried in termsof outputper unit of effective out labor. Since the pathsof A and L arenot affected,however,if outputper unit of effectivelabor risesby l}Yo, ou@utitsel is also 10%higherthanwhatit wouldhavebeen.l (b) Consumption rise lessthan output. Althoughoutputwindsup 10%higherthanwhat it would will havebeen, fact that the savingrateis hrghermeans we arenow consuming smallerfraction of the that a output. We cancalculate elasticityof consumption the respect the savingrate. Onthe balanced with to

= V 3 =l

Solutions Chapter1 to

(2) c* = 1l - s)y*. Taking derivative respect s yelds the with to

ds To tum this into an elasticity,muhlplyboth sidesof equation by s/c*: (3)

(3)

0c*

^ os

=-y*+(l -s)-i -

6V*

t= -Y * t s -' '1 s c * (l -s )y *+.-s )oy * (l - s ) y * ' 0 e

wherewe havesubstituted = (l - s)y* on the right-hand ct side. simplifying givesus -s dc* s A y* s tr, -0s c* (1-s) ds (l-s)y* Frompart (a), the second term onthe right-hand sideof (4), the elasticityof output with respect the to saving rate,equals ll2. we canusethe midpoint between = 0.15andsxrw= 0.lt to calculate s the elasticity: -0.165 dc * s - - ,- - :-=-+0.5=0.30\ ds c* (1-0165) Thusthe elasticityof consumption with respect the savingrateis approximately0.3 Sothis 20% to increase the savingratewill cause in consumption be approximately abovewhat it would havebeen. to 60lo (c) The immediate effectofthe rise in investment a fractionof ou@utis that consumption as falls. * Allftoughy* doesnotjunp immediately it only begins movetoward its new, trigheibalanced-growthto path Ievel-- we arenow savinga greaterfraction,andthus consuming smallerfraction, of this samey*. a Atthemomentoftheriseinsby3percentagepoints--sincec=(1 -s)y*andy*isunchanged-cfalli. In fact,thepercentage change c will bethepercentage in change (l - s). Now, (l - s) falls from 0.g5to in 0'82,whichisapproximatelya3.So/odrop, Thusatthemomentoftheriseins,consumptionfallsbyabout threeanda halfpercent. We canusesomeresultsfrom thetext onthe speed convergence determine lengthof time it takes of to the for consumption retumto rvhatit wouldhavebeenwithoutthe increase the savingrate After the to in initial rise in s, s remains constant throughout. Sincec = (1 - s)y, this means that consumption grow at will the samerateas y on&e way to the newbalanced growthpath In the text it is shownthat the rate of convergenceofkandy, afteralinearapproximation, isgivenbyl,= (1 - cr,*Xn +g+6) With (n +g+6) equalto 6Yoper yearand o,s= l/3, this yieldsa valuefor l, of about4yo. T\is means k andy move that abottt4Yoof the remaining distance towardtheir balanced-growth-path valuesof k* andy* eachyear. Sincecisproportionaltoy-c:(l-s)y-italsoapproachesitsnewbalanced,growth-pathvalueatthat same constant rate. That is, analogous equation (1.31)in thetext, we couldwrite to =.-(1-aKxn+s+6)t - c*], (5) c(t) - s* [c(0) or equivalently ( 6) e - r t- c (t)-c*. c(0)-c* Theterm on the right-handsideof equation is the fractionof the distance the balanced (6) to growthpath that remains betraveled. to We knowthat consumption initially by 3.5%andeventually be 6Yohigher falls will thanit wouldhave been.Thusit mustchange 9.5%onthewayto the balanced by growthpath. It will therefore equal be to = what it wouldhavebeen about36.8%(3.5W9.5o/o 36.8Yo) theway to the new balanced of growthpath.

lqurv.re'Lry'uus ls wnntneremammg drstance thenewbalanced to growthpathis 63.z%ofthe origina distance' In orderto determine lengthof time this will the take,we needto find a t* that solves =0.632. (D r-^t* Takinglogsof bothsides equation yields of (7) In(0.632). -It*: Rearranging solvefor t givesus to t* = 0.45910.04, andthus (8) t* = ll.5 years. It will takea fairly long time -- overa decade for consumption to retum to wtratit wouldhavebeenin th absence ofthe increase investment a fraction of ouput. in as Problem1.9 Definethe marginalproductof labor as w = AF6,ALyAL. Then !1) write the productionfimctionas Y = AL(k) : AL(IvAL). Takingthe partial derivativeorouput with respecr L lelds io (l) w = 0Y/0L = ALf ' (k)[-KlAL, + Af(k) = A[(-KIALX' ] &j + (k)J = Atf6.l - kf , (k)], as required. (b) Definethe marginalproductof capital as r = [dF(K,AL)/dK] - E. Again, writryrg production the frmctionas Y = ALf(k) = AL(IVAL) andnow taking ttle partial derivativeof outputwifh respect K to yields (2) r = [7Y/AK|- 6 = ALf' (kXt/ALl - 6 = f, (k) - O. Suhihrte equations and(2) intowL + rK. (l) wL + rK: Atft) - kf ' (k)l L + [f ' (k) - 5]K : ALf(k) f _ - '(k)[K/AL]AL + f , (k)K _6K. Srylifyng givesus = + !3) wL rK ALf(k) - f' (k)K + f' (k)K - 5K = Atf(k) - 6K : ALF(ML, l) - 6K. Frnally,surce is constant F retumsto scale,equation(3) canbe rewrittenas ia) wL * rK: F(ALML, AL) _6K = F(K, AL) _ Or.

(c) As shown above, r=f '(k) -6. Since6is a constantand sincekis constanton balancedgrowthpa a so is f '(k) andthusso is r. hr otherwords,on a balanced growth path,if r= 0. Thusthe Solowmodel does exhibitthepropertythat retumto capitalis constant the overtime. Smcecaprtalis paid its marginalproduct,the shareof ouput going to capitalisrKly. on a balanced grornth path,

c,mstant on the balancedgrowth path.

{rxiy) = i l r + K I K - V fV =0 +(n+g ) - (n+g )= 9. i - i) * (rKiY) Thus, a balanced on growth path, share oufrutgoing capital constant. the of to is Since shares the of onrytfr going capital laborsum one, impiies theshare to and to this that of oueutgoing labor also to is

\l-e needto determinethe growth rate of the marginal product of labor, w, on a balancedgrowth path, fu trown above, w = AF(k) -_kf '(k)l Taking the tirne derivative ofthe log ofthis expression yields the grc'wth rate ofthe marginal product of labor:

-tr'(t) -m"(t)t -kr"(k)k r={*{:fil-5!il -** [r'(t)t rs) ] -o+ =s-;p1_Jfril. o' w
A lf(k)-kf,(k)l fG)_kf,(k)

10

Solutions Chapter1 to

on a balanced growthpath k = 0 andso {w - g. That is, on a balanced growthpath,themarginal productof Iaborrisesat the rate of growthof the effectiveness rabor. of (d) As shownin part (c), the growth rateof the marginalproductof labor is -kf"(k)k (6) I=n* w - f(k)_kf(k)' If k < k*, thenasI

same term is positive because and li arepositive f (k) k and ' is negative.Thus,ask risestoward marginalproductof labor growsfasterthan k*, the on the baranci !.**.or,rr. krtuitivery,the marginar of laborrisesbythe rateofgrowth product orthe etrectiveness lublo; of o1+, baranced growthpath. fu we move from k to k*' however't\ per lnount **o*t labor moreproductiveandthis inc.eases'tlre unit orrr."t*, laboris alsorisingwhichalsomakes marginalproductof raborevenmore.

ontheright_hand:fFilxil6.,:ffi "trjffifi ftffii!,ffi iJ::;.T,.frTff l:;T".

i,, ffilHffiT"mlJ"#;fi$-Tfr1'fi*i "'-*fi air,ri,"t iig,;*. arate rhan at ress on

Problem1.10 (a) By definitiona balance'd growthpath occurswhenail the variabres ofthe modelaregrowingat constantrates' Despite differences the between modelanothe usual solow this model,it tums out that we showthat the economy converge will to a balanced growthpath by examining behar,ior ;frf"t the of k : of k = IVAL givesus rterr-rlr'n-rii* -ALLffJ= K .(t A) (r)k=[+J= = o6;;;j' substituting capital-accumulation the eguatiol,r = [an1r, eL)/aKJK -6K, andthe conshntgrowthrates of the laborforceandtechnologv, =n Lf r andA/A :,, ,;;ation (l) yrelds Takingthe time derivativeof both sidesof the defin{ion

r f,(k) f,(k) Askrisestowardk*,thisgrowthrateisnggativ-e since ,(k) > 0, f ,,(k) < 0 andk > 0. f Thus,asthe

(Dr=lIgX- r'(k)k '

The growth rateofthe marginalproduct of capital,r, is

rer/E

oL

;- -l;.ij

substituting arg,er)/a\=

(2)k=[ar(r,el)/adr -ox (n+g)k aF(K,AL). , \i = _6k_ (n+g)k. At--_ ffk

(3) [ = [r'G)-(n+g+s)Jk.

f 'G) into equation givesus = ,(k)k _6k _ (2) k f (n +g)k

or simply

capitalperunitofeffective raborwr[beconstantwhen 0, k= i.e.when ,(k) _ (n +g +6)J = condrtion k 0. This holdsifk = 0_(a case wewill ignore)-o. ,(t _ (n + g + = [f f ) 5) 0. ThusttreUaianceO_grow*r_path levelof the capitar stockper unit of effeJiveraboris impri.irrr"arn".a by f ,6.*; : (n * g + capitalper unit of effectivelabor, = E). since k IVAL, rs constant tr* i"r"".a on growth path, K mustgrow at same rateas AL' whichgrowsat raten * the g. sincetheo."ar"i""'r"rctio]r has**"iro"ms andeffective labor'whicl bothgrow i,irn to capital + g onae uatancea grovth path,ouput mustarsogrow at

Solutions ChapterI to growth path, Thuswe havefounda balanced growthpath whereall the raten * g on the balanced variablesof the modelgrow at constant rates,

II

The next stepis to showthat the economy growth path. At k : k*, actuallyconverges this balanced to f'( k) =( n +g+6). Ifk>k*,f'(k)<(n+g + 6 ). T h is f o llo ws f ro mt h e a s s u mp t io n t h a t f' ( k ) < 0 w h i c h meansthatf '(k) fallsask rises.Thusif k)k*, wehavek < 0 sothatkwill falltowardits balancedgrowth-path value.If k < k*, f '(k) > (n+g+6). Again,this followsfromtheassunptionthatf (k) < 0 " askfalls. Thusifk(k*, wehave 0 sothatkwill risetowardits whichmeansthatf rises t> '(k) value. Thus,regardless the initial valueof k (aslong as it is not zero),the balanced-growth-path of growthpath at k*, whereall the variablesin the modelaregrowingat to economy converge a balanced will rates, constant (b) The golden-rule per level of k - the levelof k that maximizes consumption unit of effectivelabor .- is definedimplicitly by f '(k*) = (n +g + 6). Graphically,this occurswhenthe slopeof the production the investment functionequals slopeof the break-even line. Notethat this is exactlythe levelof k that the economy converges in this modelwhereall capital incomeis saved all labor incomeis consumed. to and kr this model,we aresavingcapital'scontributionto output,which is the marginalproduclof capitaltimes (n the amountof capital. Ifthat contributionexceeds investment, + g + 6)k, thenk rises. If it is break-even lessthan break-even investment, falls. Thusk seftlesdownto a point wheresaving,the marginalproduct k (n investment, + g + 6)k. That is, the economy settles of capitaltimesk, equalsbreak-even doumto a point f wheref ' (k)k = (n * g + 6)k or equivalently ' (k) = (n * g + 6). Problem 1.11 (a) Theproductionfirnctionwith capital-augmenting progress givenby is technological (t) Y(t) = [A(t)K(t)]oqt)t-". (1) Dividingbothsides equation by A(t)d(t-")L19yields of
-------------7;--'-=l-----------ii|---.-|-

Y(t)

otrl*al fi

L(t)

lt-*

A(t;o/(t-c(lt,., LAqtla/<t-")r,ttl-J LAqty"/tt-o)r,t,lJ'

and simplifying:

Y(t) A{t;0/(l-alt,r, andthusfinally

_c{)A l" t- -al( l-o )r(t) (t)-r KG) A(t)r A1t;1-ol(l _L L( t) -l =[ L(t) ]"on'-"

Y(t) ;(0tG[(0

*al [ =L;(gAG*) l" L(t) i

Now, defining0 = o'{1 - a), k(t): K(tyA(t)ol(t) andy(t) = Y(tyA(t)ot (t) yrens (2) v(t): k(t)". In orderto analyzethe dynamics k(t), takethetime derivative bothsides k(t) = K(t)/AG)0L(t): of of of

rltl[e1t;+ - rttl[+ettlo-te(,)r,(.) rltd * L1t)e1q0] k 1t , = ' r ' ' - d 'L(t)l +

IA(t)Y

12

Solutions Chapter1 to

k(t)= K,(t) - K(t) l-*oal * -;('F --\-/ .--@l j' a(t)o r(t) Lft) A(,) L(r) Le
andthenusing = K(tyA(t)sr6y,A6y/a(t) = p anO k(t) L(t)/L(t) = n yrelds (3) L(t) = r(t)/e(t)o (t) - (gp+n)k(t). Theevolution ofthetstal capitar stock given is bytheusual (4) K(t) = sY(t)-6K{t) Substituting (a) equation into(3) gives us t 1t;= sv1tl/e6y$ L(t) - oK(t)/aAlo L(t) _ (gp+ n)k(t) = sy(t)_ (0p+ n + s)k(t) Finally,using (2),y(t) = k(t)",wehave equatim (t t(t) = sk(t)o- (0p+n +E)k(t).
Equation(5) is very similarto the basicequation goveming dynamics the ofthe Solowmodelwith labor-augmenting technological progress.Here, however, aremeasuring units of A(t)ol,(t) we in ratherthan in units of effectivelabor, A(t)L(t). Usingthe same graphicaltechnique with the as basicSolowmodel,we cangraphbo0l components k1t). See figure at right. of the
(0p+n+6)k(t)

Whenactualinvestment unit of A(t)al(t), per sk(t)", exceeds break-even investment *ft of pr, A(t)al(t), grvur by (Sp + n + 6)k(t), k wiII rise towqrd k*. Whenactualinvestment unit of per k(t) = K(t)/A(0q-(t) A(t)ol(t) falls shortof break-even investment per unit of A(00L(t), k will fall towardk* Ignoring tle casein whichthe initial levelof k is zero,the economy converge a situationin which k is constant will to at k*. Sincey : ko, y will alsobe constant whenthe economy converges k*. to Thetotal capital stock'K, canbe written as A0Lk. Thuswhenk is constant, will be growingat the K constant rateof {p + n. Similarly,total output,Y, canbe written as AsLy. thus when'yrs constant, outputgrowsat the constant of rate $p + n aswelt. since L andA grow at constant ratesby assumption, we havefounda balanced growthp"th *hutu all the rrariables oitt. .oa"l grow at constant rates. (b) Theproductionfimction is now givenby (6) Y(t) = J(t)o L(t)l-".

(7) y(t) =let,littl " L(r)t*.

Definei(t) = J(tyA(t) Theproductionfunctior can thenbewritten as

Proceed in part (a). Divide both sidesof equation as (7) byA(t)"{r -"\,(t) and srmplfy to obtain

A(t;ortt*)t(t) LAlt;"itt-o)r,fO_J' Now,defining = crl(l - o), J(t) = r1t;/A(t)el(t) and = y(tyA6;"L1t) $ yrerds v(t) (q) v(t): j(t)".

(s)

TIt). =l-----tr,l -]"

1 to Solutions ChaPter of j(t), takethetime derivative bothsides J(t) = J(t) leG)\'(t). of

i3

of the In orderto analyze dynamics

[et.loL(t)]2
= L1t)/L1t) n vrelds then and ur-g jfti = I (t)la(t)ol(t),A(t)/A(t)= p ana (10)j(t) =ittl/nt.l$ r,(t)- (0p+n)J(t).
of of bothsides J(t) = J(t)/A(t) : ror Thenextstepis to getan expression i(t) . Takethetime derivative A(t) (!l ittl - I(t)A(t) -' " 'J\L'- i(t)A(t) f/+\=- A(t) A(t) A(t) A(t)2 j1t1= t61t;Y(t) - 6J(t) to obtain Now user1t; = J(t)/A(t), A(t)/A(t) = prand . sA(t)y(r) _6J(t) _ uJ(t). J(t)=-;(t) A(t) or simply ( t t) l( t) = sY (t)- (P +6)J(t) (10): (1 equation 1) into equation Substitute

ial [, ,qal* L(t)l . i(t) j(t)=;(t)o I' La 11t) ;(,f Lft) A(.) L(,)

-"jl;;=rtttl/n6i+l,Al-f**ol]tO/,rAloL(t)-($rr+")J(t)=sy(t)-[n+6+p(t+$;]J1t1.
(9), equation y(t) : J(t)", wehave using Finally, -[n ( 1 2 )j ( t )=s](t)o *5 +p (l +S l l ]ttl . of boft componentsj(t)' wecangraph model, Solow as tecbnique in thebasic graphical usingthesame
the See figure at right. Ignoringthe that possibility the initial valueof j is to will zero,the economY converge a at *' situationwhereJ is constant j *, when y Since = J y will alsobe constant to converges J *. theeconomy The level of total outPut,Y, canbe written as AoLy. ThuswhenY is rate ouFut growsat the constant constant, o f $ p +n. the J By definition, = AaLJ. Once
economy convergesto the situation where J is constant, f grows atthe constant

ln+6+ p( 1+4n J ( t)
sj(r)"

= ]1ty rttl/xt)sut)

J, stock, grow:atrate0p+n + porn + p(l+ $)' Thus capital rateof $p+n. Since;= f A,the effective of growthpath whereall the variabres the modelaregrowingat a balanced to doesconverge the economy rates. constant

I4

Solutions to Chapter I

(c) On the balanced growthpath,

si"=[n +0+p(t+O )J J=
andthus (13) j* =

J(t) = 0 andthusfrom equation (12):

j t* = s / [ n + 6 + p ( l+ g ) ] ,

Vtt-cl. [r/(' +6 + p(l +qy)] substituteequation (13) into equafion to get an expression output (9) for per unit of R(t)or(t) on the balanced growthpath: [r(n +6 + p(t +4;)]a/{t-gl. Takethe derivativeof y* with respect s: to 6b /* [o l[
- :t

(14) y* =

trnorderto tum this an elasticity,muhiply both sidesby s/y* usingthe expression y* from equation 1t9 for (14) on the right-hand side:

Ll-alfn+o+p(r+4)J L;.6;ilI.d]
-

tt

T/(t-ol-r[
I I

r
r

Simplifyingyields

1 ctl( t- cF t; I f o* r= l - o _ l f r . lf & y * L r - a _ l l n + o + p ( r + 6) J L - - - :- il_ lsln + s1 u m j

1 - cr /( r - a )

and thus finally

o y * =Lr-"Jt s Io 1l-n+o+rr(r+O)ll, I a r, p(l+O)J, JL;+6+

& v* I -or-

(t s ) f o* t = o
(d) A first-orderTaylor approximation y of aroundthe balanced-growth-path valueof y: y* will be of the form

QQy=fo/fulr=r.lvv*].
(r7) i=oj"-lj. y=
or
Taking the time derivative of both sidesof equation (9) yields

Substitute equation into equation (12) (17):

"J'-t[$"

-(n +6+ p(l++,j] ,

Equation(18) expresses in termsof j' J w" canexpress in termsof y: sincey = j o, we canwrite J = yt'". Thu_s dj,/Q, evaluated y = y* is givor by J a! '[, avl -ierl llu;l L r)J2("-rr +6+ po.o))] flr=r.=L;;lr=r.-jl#lr=r.-J= -o21"-r1n [so(2a-

(18)i= soJ2c'-t -"f tr +o+p(r+p)].

Now,fr 'crlcr simplyJ t'" since = J" andthus i, y J ^ .1 wl _^ =s(2a-1;J2(o-r)+1t-c1 -*a-1+(1-o)[n+o + p(1+Q)]= s(2cr l)jcr-l #l o[n +6 + p(i+g)]
"'y=y*

f;y(,-")/"]

1 to Solutions ChaPler

15

(13)to ,=J'*[n+6+ for Fmally, substituteout s byrearrangingequation obtain

p(t +S)] andthus

=J r* [n+6+p(l +{)](2 a - l) J c c-rr[ n + 6 + p ( l+ S ) ] , -{ ?l ayly=y*

or srmply =-(1-a)[n+6+p(l+$)]. ( le ) :j - l ryly=y* (16) (19) into equation givesthe first-order Taylorexpansion: Substituting equation ( 20 ) i = - (t-e)[n +6+ p(l+g)] [v-v- ] Solvingthis differentialequation(as in thetext) yrelds (21) v(t) - y* = r-(l-c)[n+6+p(1+0)] - v *] [v(o) toward y* distance movesfraction (l - a)[n + 6 + p(l + $)] of the remaining This means the economy that year. each (e) Theelasticity ou@ut in to with respect s is the same this modelasin the basicSolowmodel. The of is in this model. In the basic Solowmodel,the rateof convergence givenby is speed convergence faster of (1 -oXn+6+pl,whichislessthantherateofconvergenceinthismodel,(1 -cr,Xn+6+p(l+$)l,since = oJ(l - cr)is positive. $ Problem 1.12 for (a) The growth-accounting of technique Section1.7 yreldsthe following expression the growth rate of outputper person: L(t)J Y( t) L(t) to wherecr6(t) is the elasticityof outputwith respect capitalat time t andR(t) is the Solowresidual. growth is equation a Soloweconomythat on its balanced to Now imagineapplyingthis growth-accounting growthpath,the growthratesof outputper worker andcapitalper worker areboth path. Onthe balanced (1) would attributea equalto g, the growthrate of A. Thus equation impliesthat growthaccounting fraction cK of grov/thin output per workerto growth in capitalper worker. It would attributethe rest progress, this is whatwouldbe left in the Solowresidual.Sowith our as fractionI - crx- to technological of attribute about670/o the growthin outputper of usualestimate crs: l/3, grouth accountingwould progress about33o/o fhegrowth in outputper workerto growthin capital of and workerto technological perworker. it sense wouldnot: the (b) h an accounting sense, resultin part (a) would betrue, but in a deeper the growthpath is because effectiveness the reason the capital-laborratio growsat rateg on the balanced that of of labor is growingat raleg. That is, the growthin the effectiveness labor - the grornthin A -- raises First,by directlyraisingoutputbut alsoby (for a givensavrng outputperworkerthroughtwo channels. ratio. raising capital-labor the to and devoted capitalaccumulation thereby rate)increasing resources the channel growth in the to Growth accounting attributesthe rise in ouQut per workerthroughthe second growth accounting ofteninstructive, is not to its underlyingsource. Thus,although capital-laborratio, and of light on the underlyingdeterminants growth, it is not appropriate interpretit as shedding to
a, l ( /l

^. 1

,)

Y(qgq=**(t)[Iq- 59.l*nttr, "' 'LK (t)

f ruuttllt

l.lJ

(a) Ordinaryleastsquares (OLS) yieldsa biasedestimate ifthe ofthe slopecoefficientof a regression explanatory wifh the error term. We aregiventhat variableis correlated

=a+bh[(y/N),rroJ and (r) h[(y/N),nrnl +e, -r"[(v/N)razoJ = (2) ln[(v/N),rrojh[(Y/N)rs?ol u, *

It r I It r 1*

It

lr

l*

lr

l*

1870incom with eachotherandwith the true unobservable to wheree andu areassumed be uncorrelated per person ln[(YA.{)trro]*. variable, (2) yields Substituting equation into (l) andrearranging

(3) h

= - r" . *ro] " * bh [(y/N)r*ro]* [" - (r + b)u] [(y/N),nrn [(v/r.r), ]

is wit Runningan OLS regression model(3) will yrelda biasedestimate b if ln[(YA{)rs70] correlated on of of error the errorterm, [e - (l + b)u]. In general, course, will bethe casesinceu is the measurenent this that that helpsto determine valueof ln[(YAI)t376] we getto observe.However,in the specialcasein the since rryhich true valueof b = -1, the errorterm in model(3) is simplye. Thus OLS will be unbiased the no longerbe correlated variablewill with the errorterm. the explanatory

(b) Measurement variablewill not cause problemfor OLS estimation is, in error in the dependent and a fact, oneof thejustificatiors for the disturbance term in a regression model. Intuitively, ifthe measurem per error is in 1870income capita,the explanatory variable,therewill be a biastoward findurg growth is understated. If This lookslike convergenc convergence. 1870incomeper capitais overstated, grow countrygrowingslowly. Similarly, if 1870incomeper capitais understated, a 'high" initial income growingquickly. is overstated.This alsolookslike convergence: "low" initial incomecountry a

measuremen instead Suppose that it is only 1979incomeper capitathat is subject random,mean-zero to is overstated is growthfor a givenlevelof 1870income.When1979incon so error. When1979income 1979incon is understated, is growthfor a given 1870income. Eithercaseis equallylikely: overstating so error is on it for any give,n1870incomeis just as likely as understating (or moreprecisely,measurement fot us cause to seemoreor less average equalto zero). Thusthereis no reason this to systematically convergence therereally is in the data. than Problem 1.14 growthpath is that K andY are eachgrowingat a constant rate. The for What is needed a balanced equation motionfor capital,f1t; = sY(t) -6K(t), implies growthrateof K is of the Y(t) K(t)
(t ) -=s--d .

K(t) K(t) As in the modelin thetext, Y/K mustbe constant orderfor the grornthrate of K to be constant.That ir in the growth ratesof Y andK mustbe equal.

function,Y(t) = K(t)o R(t)PT(t)T [et,ll-t l]t-o-p-v, yrelds Takinglogsof bothsides ofthe production : alnK(t) + plnR(t) + ylnT(t) + (1 - o - F - y)tlnA(t) + hl(t)l (2) lnY(t)
(?)

Solutions &apter I to

17

(1-ct)n+ (1-ct-F-y)e tsl gl*o_

l -c t

Substitutingin the factsthat the growttrratesof R, T, andL are all equalto n andthe $owth rateof A is equalto g givesus Sv(t) =ogK (t) + Bn+ yn+ (t _ o _ p _ y)(n +g). Simpli$ring givesus =aer(t)+(B +y)n +(l-a )n -(F + y )n + (l_ o _ F * y )g ,n , Ey(t) (4.) =orBK + (t _o)n + (l _cl _ _ y)g (t) F using the fact that gv andgKmustbe equalon a balanced growthpattrleaves with us 8y = crgy+ (l - cr)n+ (1 - cr- F -Dg, = _(1.o)g" (l - cr)n+ (l - ct - F -y)g, andthus the growth rate- outp_ut ar baranced of on growthpath is givenby

(3) ev(t)=osK(t) Fsn(t) + +7g1(t) (1_a_F_y)[ea + (t)+er(t)1.

Thegrowth rateof outputper worker on the baranced growthpath is

=g+* s+'E - gl*

_ (l-a-F-y)e rol alg p v,L

l- c[

using equation andthe fact that L growsat raten, (5) we canwrite (l-ct)n+(1-'-F-y)g =b sp tsYr t.=ff-n= l_ a Andthusfinally

Equation is identical equation (6) to (1.50)in thetext.