Crawford School of Economics and Government IDEC8015 Mathematical Methods in Applied Economics Semester 1, 2012 Assignment 3

There are 3 questions containing 10 parts, each part is worth 10 marks, due Monday 14/5/2012 at 12 noon. Hand into the IDEC8015 box in front of the Student Service, Crawford building #132. Read this instruction carefully before doing the assignment The following conditions apply: Late and typed submissions are not accepted. You are free to discuss any questions with your classmate(s) but must write (not type) your own submission and must not copy from any one. Partially or totally copied submissions (even with deliberate minor changes) will be regarded as plagiarism and processed in accordance with the Schools policy on Academic Honesty (see the course outline). If, based on reading a submission alone, the marker(s) is unable to determine whether it is an honest academic work, the author may be required to explain and must demonstrate the full understanding of the answer(s). It is the responsibility of all authors to ensure their answers are written in a clear, eligible and understandable way to the marker(s). Failure to do so will cause full or partial subtractions of marks. In order to avoid losing marks for unclear/confusing answers or even being questioned on the academic honesty, you should convince the marker(s) that you have a full understanding of your answers. Here are some tips: Don't just write down lists of symbols. Explain what you are doing in words in advance. Logical connectives such as `therefore', `because', `if...then' and so on are very important in explaining the logic of what you are doing, though you can use arrow for intermediate mathematical derivations. You may use results/conclusions/remarks in the lectures/textbook/tutorials, but should refer to them clearly. For example, say As concluded in section 3.1,... or Using the results from question 3, tutorial 2 or By the intermediate value theorem. Don't leave out logical explanations, but try to eliminate all irrelevant material. Keep your answer concise as the perfect answer for any question is not long. Draw a diagram if it is at all possible. Diagrams help you both to solve the problem in the first place, and to explain your solution to others. For example, with the question show that if A is symmetric, then A-1 (if existent) is also symmetric., a good (but not the only) way to write the answer is as follows: By definition (of the inverse), AA-1=I. Hence, transposing both sides and applying the fact that I is a symmetric (identity) matrix give: (AA-1)=I=I. Applying the property of transposing a product of two matrices, we have (A-1)A=I (A-1)A=I or (A-1) is the inverse of A. As the inverse is unique (section 4.3, supplementary note 1), (A-1)=A-1 or A-1 is a symmetric matrix by definition 1

Question 1 This question analyses the Solow growth model and golden rule saving rate! Let output of an economy be given by yt = kt for 0 < < 1 where yt is the output and kt is capital stock. In each period of time, the capital stock depreciates at rate ( 0,1) . A certain proportion, s , of the output is saved and accumulated to the capital stock in the next period. (a) Write down two difference equations that describe the transition and the change of the capital stock over time. Calculate the positive steady state and determine whether it is (locally) stable or unstable. What are the output and consumption at this steady state? (b) Draw two phase diagrams for the transition and the change of the capital stocks. (c) Suppose the economy can change the saving rate s , then what is the saving rate that maximizes the consumption at the steady state. Question 2 Dynamic Cournot-style competition model! Two producers ( X and Y ) share a market with an inverse function pt = 120 ( xt + yt ) where xt , yt are the quantities supplied by the two producers and pt is the sale price in period t . For simplicity, assume that both of producers incur no cost to produce the product. (a) Write down the profit functions of the two firms in period t . (b) At the beginning of period t, each firm determines the quantity it will supply in the period to maximize the profit. The firm does so with an assumption that the opponent does not change the output from the last period. Write down the profit maximization of each firm and solve for the feedback rule. (c) Write down the system of difference equations that describes the behavior of the two firms in the context of part (b)? When do both firms have no incentives to change their outputs over time? (d) Suppose the initial outputs of the two firms are different from part (c), will they converge? Why? Question 3 Optimal saving model An individual has decided that the optimal consumption profile ct with t = 0,1, 2,... will 1 decrease at a constant rate = with > 0 . That means the consumption in the next 1+ period will be times the consumption in the current period. The individual is endowed with a certain initial amount of wealth w0 in a bank account and is offered a constant interest rate r 0, for the account balance in any period of time. At the end of each period, 1+ the interest will be credited to and the consumption will be debited from the account. (a) Write down a system of difference equations that describes the evolution of the wealth at the beginning of each period and the consumption in a period of time. (b) Solve the system of difference equations. What is the initial consumption level c0 this individual should have to make the system converge? Draw a phase diagram for this case. (c) Suppose this individual is a father who wants to leave half of his initial wealth to his son when he dies at time T = 90 . Solve for his consumption and wealth profiles as functions of time.