SOLUTIONS MANUAL TO ACCOMPAKY ROMER ADVANCED MACROECONOMICS JERFREY ROWALYIrwin/McGraw-Hill ego GoP;GoPscs8 PrinirBincer Greycen Press “This solutions manus is designed to accompany Advan Macroecnamic by David Roms. contains suggested solution eal ofthe endochapter problems, wi he exception of Some ofthe oops exerciues Ihave made every tempt to provide avery deal, sip-bystep answer to each problem Only base slgebrate manipulauons have bes occasionally ted Comments and suggestions for inpovement are welcomed and should be addressed to Jetrey Reha, Departmen of Economics, Universty of Cahfomsa, Barely, Califia 94720, can alsobe resched via e-mail at rohaly@econ berkeley la 1 would lke to thank David Romer for is geerous lp wh this manual. He provided many sopgestions and corrections that have erty improved the quality ofthese answers, Any eros that may remain ate, of couse, ny oveSider Problem 2) Since there 20 technological progress, we can carry ct teenie analysis in terms of capital and ‘uct per worker ruber han eapral nd out pe unit of effective labor. With A constant, they bebave ‘Gevame. Thus fr the purposes of this problem we cn define y « Y/L and k » KIL. “Te filth population grovch rate makes the tyeak-even esment lie fazer. Inthe sbrence of technological progress, the per unt {ane change capa per worker, sven by Cy Kr sf(k)= (Geek. Since & was 0 before the decease ina ~ the economy was on balanced growth path ~ the decrease inn causes k to (oan # frcome portive, At, acral investment per woke, Si), now exceeds breakeven invesment per worker, Oye + B)K™. Thus k mover 3 new higher balanad-growth-pah level ~ se the diagram, ‘As rises,y ~ ouput per worker — also rises ‘Sisce a constant action of ouput saved, ¢— consumption per worker — ses as y mses. This ‘eal eummarzed nthe diagrams below. ©) By definition, output can be writen 38 YaLy, Thus the growth rte of ouput is YIV=ULes/y. On the ital balanced growth th, 5/20 = apn pr works it constant ~ 50 Y/V =L/L=n. Onthe fal balanced growth th, y= 0 again ~ output por worker iz oestant again ~and so Y/Y = L/L= mygew 0 £4 oil be pov Now se ete (2) nd he second anv wh spc te Fk ef [yeep -feP HA] fom fh H FM of OH JMO poh] ‘We ean factor te exresson as flows Foapalyerlfyertie J {gto siti ingen 2 ie oe ‘We tow that fork 0, (FG) > 0. Ths "wil be negative when the fllownng condition bos * kM eco > ATCSaluvons to Chater 1 Rico => m0 ‘Thos £* ) <0 forall postive values of 4 Wekave fay Me jerome aa oP ee weet i £16) in - at = wtho>t ties £4) = tim Ww Problem 1 23) At sometime ~ call ity ~ theres | eiscrete upward jump inthe rumber of workers. This reduces the amouot of capa pr unt of ‘fective bor from k* 19 ew. We ‘an see his by simply lonking tthe 0, this fll inthe amount of eaptal per anit of tffecive aborreces the amount of ‘utp per un of effective abor a8 swell nthe agra, falls fiom y* oye" 8) Now ai this lower ew actual ‘avert pr ut of effeaive labor exceeds break-even investment per uni of effective labor. Tha i Moen) >(g-+Skyaw The soonamy is now saving and vering more than eno to offset depreciation and technological progress a this lower kaw Thus k begins rising back toward k*. As ‘pital per unt ofeffecive abor begins sing, so does ouput er unt of effec labor. Tat i, y begins sing fom aw back toward y* ©) Capital pr unit of effcsive labor will coniueto is nt eveualyreturas tothe original evel of Es Ath, nvesment per unt of effecve labor is aga jst ough to oe technological progress and depreciation and Keep k constant Since k returns tots ongmal valu of ence the economy again recurs tof balanced groweh path, ouput per un of effective labor also retums tots gaa value of "= Rk") Problem ‘Tae derive of y* =) with espero is given by (D ayrin = (44/00) “Toind c/o se the equation forthe evoltion ofthe eptl stock per unit of effective labor, f(k) (0-45 +8)k. laadtn, use the fot that on a balanest growth pat, k=0, k=K* and thos Mk) = (n= g+ 5)" Taking the derivative of both sides ofthis expression wih respect tom yields & a 30) negra Syke er) Satara Solutions to Chapter 1s and arangig elt: = te he ere Substingeqeation 2 to eatin (1) gives us Pa =u) foe 6 ayer) tearge he conn that impli des *~ fk) =(o ++ Okt ~and sae fr siding ppereren cy Sosa equation) fo eusin (): ee Toe © ere DREN AG woe “Torum is ioe els hat we want, mali bath tes of equation (5) by 2a Pees tae) Fo eres) RGNK AGNI ang the definition at 0) = POE KOT) ge yee nf agi) | a Greed Lima o® ana Now, with (4) = 13, 74, we nent calcul the effect on y* of fallin a from 29% to I%. Using the midpoint of ar ow (48 Ya Goons -oare00s) WT-173 Sothis 50% drop athe population grow ate (Fem 2%to 19) wil endo a (0.50) (-0.12) = (Meincresce nthe level of onpit pe Un of efectiv abe This iusats the pos that observed ‘Gffrmees in population growth rer across counties are at neatly enough to account for differences in y that we se, O15 to calculate the elaicny gives us Problem 1.6 2) Assuring that avesmentrige by the ful amount ofthe lin he def, the hare of outa that is Alvord to investment ~ the saving ate ~ should nse fom $= 015 to syay = 0.18. Nowe that thi i 20% ‘ncresue nthe saving rate (0.03 is 20% of 0.15). From equa (1.72) the tx, he elasicty of out ‘wh expect othe saving ati ty Eg SRD yt & “eg whet a (i the share of income paid to capital (assuming that capa spi its marginal produ), We are tld to asume that ag (?)= 1. Substruting his in gives us Say at) V3 1 ¥ Trag@) 1-132 Thur the elasticity of epi wath respect tothe saving ates 12. So this 20% increas inthe saving rate = fom" 0 15 0 saw "0.18 ~wil cause outpetorierltive fo what woul have been by about 10%. For sucha huge poiey change tral elumapatca of the budget deft ~ ths appears tobe a rather ‘modest benefit [Note thatthe analyse hae realy been camed out interme of ouput er anit of effecive6 Solutions to Chaper | labor. Since the path of A and L arena affected, however, f up per unt of effective labor ries by 10%, ouput tent also 10% ghar han what would have Baz ») Consumptic wll ite eve lee than expt Although output winds up L0% higher than what woud Ihave bea, the Fac ha the svg rates hgher means that we ae consuming a smaller faction of outpct than before the defiet redaction Thus we donot gett enjoy the enize 103s increase in Out 88 increstedconsumpoen. Note tha by consumption, we are imple including goverment purchases ‘We can ealeulate the els of consumpion wa respect tthe saving rate On the balanced growth ath, consumption is gbven by @ e=a-ay" Taking the derivative wih respect to yells “Tour this into an elasty, multiply both sides of equatien (3) by se fer eave as ee aay ee Toaye where we have substtuted * = (1-5)y* on the nighthand side. Simplifying gives us ens tt o oe e*G-8)” & (-ay* From part, the socnd tem ~ the elaicity of ouput with esac tothe saving rate ~ i equal 0 W/2. We can use the mudpout baten £= 0.15 and Shaw = 0.18 calculate the arity Bet ON, a er 0165) ‘Thus the elasticity of consumption with respect tothe saving rate is approximately 03. Sothis 20% increase athe svg fate — fom $= 0.15 to pew = 0.18 ~ wil lead to cenmompion being approximately 6% sbove what would have been. Again, the Solow mode! pel nly madert benefits from rather large change in goverment policy. ©) The immadias effet ofthe deficit rducon is that easumption fl Alhough y* does ct jump immediately ~ only begins to move towards bet, higher balance! growth pth level ~ we afe now svg a greater fraction and thus consuming a smaller Eacuon ofthis same y* At the moment of te tee ins by 3 percentage pots ~ since c= (1 -s)y* andy" is unchanged ~e falls Ia fa, the percentage change ine willbe the percentage change in (1-5). Now, (1 ~s) fal from 085 to 0 82, whichis agproximatcly a3 5% drop ~ 0.03 is about 3.5% of 0.88. Thus athe moment ofthe seas, consumptie falls by about three and a half percent \We ean use some result from te text onthe sped of convergence to deine how long it takes for contumgsio to resam to what would have doen wthow te defi reduction, Afr the mil rise a s© remains constant tvoughos Since c= (I= #y, thie mans that consumption wil row athe same rte {yon the way tothe sew balanced gro path in the ext te show tha the ate of ecavergence of k and {y~aflera inca approumati ~is even by A= (I~. n+ g #8). Wath (9+ 48) = 6% per year mid ‘ax 173, this yes 2.24% ‘This means that kand y move 4% ofthe remain distance toward tec balanced-growthpath values of kt andy" each year. Since cs proporional ty ~¢= (= 2)y = it alo approaches ts new talancad-growth-gath value at hat same consart ae. That is, analogous to equation (126) detent, we could wre © alo nat eH eC) “) Soltions Chapter) 7 or equivalent eo me ‘The tem on the right-hand side of equation (6) the faction ofthe distance tothe balanced growth path that rnaine to betaveled ‘We now that consungsin il iiialy by 35% and wil eventually be 696 higher ha would have been. Thus t mus change by 95% an the vay tothe balanced grow path, Iwill hrefore be equ! what t would have boen, 3.99 5% = 36.8% ofthe way othe ne alaned growth path. Equvalety, ‘his when the rematning dizance to the new balanad growth paths 63.2% af he ecgial stance In ‘order to Find cut how lang ths wil take, we end to id 21" that sles @ &* =06: “Taking the naval log of bth sides of equation (7) yl: Atte tn(0632) = 04891008 andthe (@ E115 yous [ew take aft long time ~ over a decade ~ for consumption orem to what it would have been inthe abamnce ofthe dei reduction ble 1.7 2) Defie the marvinal product of labor as w = 2E(K,ALVCL. Then wres the production incon as ALf(e) = ALITR/AL), Taking the partial denvative of uu wah respect to Ll: () we OY/2L = ALE" Q)-AUAL } + Affe) = AICIUAL)E" +] = ALAR) KFC) So we do have w= Aff) = KF") 1) Define de marginal product of capital as = F(KALYK. Ago, wring the production funcion a¢ ALE) = ALAKVAL) and now talng the pial denvatve of ouput wath empoct to K yas ( 12 2YIKK = ALE (LUAL]=£°) Sebsttute equations (1) and (2) ito w+ 1K wht rR AAR) =A] LF GOK = ALM) - FQ KVALTAL + (3K Senplifying gives us @) WL FR ALfll) -#°00K +" GOK = ALA) = ALFIK/AL, 1) Finally, since F is constant reams o scale, equation (3) can be rewrite as: (w+ i= FIALWAL, AL)=F(K, AL) ©) As shown stove, =). Since kis const ona balincd roth pth 0s) and thus In cther words, ons tlanced growth pa, =O. Ti fen of Fars syd acaba powth which athe em to copia i approniatly constant Since epee pais marge rode, he Sore of pi gong to cpl KAY On tlc owt ah (a (ma) “Thus cn a balancd gro path the sare of ouput gogo capa is conta Soe he shares of ut sto capa sd lor smo ts nplis at sar of en gong to lb isl const on tbe alc prow pas $HfesW/K-V/V=0+(0+8)-(a+)=0 fi bSolutions to Chapter 1 4) Wo nod to dataonine wat ic happening tothe grow rate of w 36 kes toward k* As shown above, (f) 111). Taking te ume dervauve of te logo ts expression yee the grow ate ofthe ‘argnal produc of aber: (rook ‘Ts is uve because the denominator i postive since RK) ia concave fiction, wil the numerator s postive because k and k are postive while f* (kis negauve. Thus the marginal produc of Ibori ‘rowing faster than onthe balanced grow path Intl, the marginal product of abor ries bythe Inte of growth of the effectiveness of labor on the balanced growth pth since thats what is mereaing the ‘marginal preductoflaber. As we move fom kok", bowever the amount of capital per une of effective labors also sm which also makes labor more producuve an this iereases the marginal produc of labor even more ‘The growth ate ofthe marginal product of capa, is + [roel _ Po ra) FO, ‘Tis growth aes negative since £"(K)>0,£"(k) Oas kis towards kt Thus asthe conan moves fom k tok, the marginal produc of capa lls That grows at a ate less than on the balanced growth path whereas growth fate iO. Problem 1.8 2) By diana balanced growth pth is when al he vavables ofthe adel ae growing constant ‘aus’ Despite te dierences betwen ths made andthe wal Slow madeline out hat we can agin show tht the eenomy vl converge toa balanced rot path by examining the behavior of k= K/AL “Taking the ine derive of both ses of he defen of = KIAL ie fy bef #) NAD=KILA-AL] KY LavAL] “aan? at acl” at Subst he apa accumultion equation ~ K = F(K,AL/2K]K ~8K andthe constant growth rae ofthe labo ce and tecnology ~ L/L=nand A/A =~ to eqn () yal ay «LF AD eR] aK a Subsining 2FOKALYEK = 10) ito equation 2) ges ws k= PIO -Bk (0 +4) oF simply ©) k=[P0-(ar8+5)k Cai pr unit of effive abor wil be constant when =O, i¢ when f° ()-(a-+¢ + 8)}k=0. This condcon wi old k= (a case we wil gore) or when") => g 8) =0. Thus the balanced soveh th level of be expt sock per uni of efictve abr implcy defied by € Ke) = (ns + 8) Since capital per unit of effective labor, k KUAL, is constant on the balanced growth path, K mist grow aethe same ate as AL, which en +g Since the production function Ras enstan eure fo captal and effecive abr, which bh grow at ate a * gn he laced growth pth, expt mus also grow ate 1+ gon th balanced growth path, Thus we have indeed fund 2 balanced prow path wee al the ‘ables ofthe model grow af conan et, _ IK AL) (a+ pk k-tk-(a+e)k ‘The next stop ie to show that the economy actully converges to thie Blanca grownh path Atk, £°0)=(@ #8) I>, FQ) <(0->g-+ 5) This because we are assuming at F< 0 meaning that” () falls as krtaes Thus > Kt, weave ke Oo hat wl fl toward ts blancs Solstionsto Chapter! 9 grombsgath vale Ifle ht, £°()> (a+ g +8), The because we ae assuming that f° (k) <0 rreanng that f°) ges ask fils. Thus if k Oso thatk wil ise toward ts balanced rowdh-pathvahie Thar regardless ofthe ia vale of (log 35 is et k= 0), the ecenamy el Eesverge to 3 balanced gronth path ak, wheel the vanabes in he model ate growing a a eanstat by The glden-us level of k~ the eel ofthat maize consution pa uit of effective labor — is ‘efacd mpl by ©) = (a +g +8), which canbe interpreted graphically athe slope of the production function being ual tothe slope ofthe break-even investment ne Note that thsi exacly the level of that he economy converges to ere where all eapial nome is saved and all labor income is ensued, In thie mode, we are saving cpt contribution to utp, hich ie the marginal product of capital times ‘he amount of apeal.Ifthatcontnbutonexcode break-even inverment (0+ g + S)k-—K nics. Wis Jes than break-even investment, fall. Thus k sees down toa pomt where saving ~ the marginal product of capital times k-~ equals break-even investment ~ (n+ g+ Sk. That, the economy sees fw toa pout where f'(Qk= (n+ g-+ kor equivalently "(= (n+ +8). Problem 1.2 2) Since te lbor force giows exponentially arate — L(t) = aL(t) —we can write the labor force at @ L@ =e" Lo Using equation (1), the amount of effective abr at imei given by DAP LO =F PLO =a oO) Soe ex K(O) =e, L(0) and thus solving fer 10}: © LO) = fee KO, Substituting equation G3) into equation 2) yi ce Le) ere fo KOE, cox snply © cee LQ) = exe KO) ‘Tras e¢ Kid ep €™ Li) for ali equivalent too Kit © KO=e"" KO) fer alle Enuatcn (5) simply sates Wat the capt ck grows exponentially at ate (a) Thus ‘6 K() =e, LQ) for ati equralet to © Kw/Kay=ntg forallt se e°® Ki) fo alto sply ow, dividing the epital accumulation equation — K(t)=¥(t) = BK(t) = by Kip yeh Key sto @ SOMO, Ka” Ko, Svbstneing the production Function ito eqution (1) gives ws Keo _s-malerkenerst Lo] Ke KO Wi Ke) = ox oF (frat, we can wnt i og Ki), cee” Li) 5 sqution (6) ec KO)™ e &” Lt) for all equivalent to RW) 5 Ka) ® ce Kt), Using this fact as well10 Solutions to Chapter esl (oy at pean “Thus cx Ki) = 61 & Li) forall ifthe parameters are such tht equation (10) olde, Cleaty there is ne paticular reason to believe that equation (10) must hold 1) Teco Lg is groming farterthan ex K(Q), the ameust of labor hat exceeds Kt) wil be tnemployed. Since cy K(O)~ 0, LO), he difference betwaen the quart of effertive labor andthe ‘quantity of capa i sing overtime Thats, the quantity of anployed peopl wil be ising overtime fd the unemployment rate will approach 100% 6) Wo: Kise growing faster han cy Li), te amount of ep hat exceed ye Lt) wil ot be Uilized Since cx K(O) =e. L(O), the difference beeen the quatzy of capa and the quantity of effective lar esi ove tine Thus the ration ofthe capital sock that et utlzed will be nsng a) We already have by assumption that A/A =g, L/L=n and R/R=0. Thus we need to show that seryeriricemmme ag Ut wth eater cae cee Tigao ace D BKK" KKK EEE Tosi sttapuom fem ph tne K a) Rg As long as K/K is constant, then ¥/Y will be constant as well. Thus we need to show that the economy. ‘converges to a situation where the growth rate of capital, gx « K/K,, is constant — that is, a situation where te = {K/h cervtive of (K/K) wih respect ie, 0 ee ay “Taking the derivative of baths of equation (1) with pet oti ik aoe eee), | ate Sle Kt] © tke eK Rearrangingequton 2) tsa forthe change in iptv: 4) Y=Yfogx +Pcn+8)) Sensing sui (at ton) eh Mee VD Fy fe Eleven + Heel erranging equation (I) yields (9 Y/Ke gp +3 Subst equation (6 io equation (9) elds 9) x=] Solutions to Chapter 11 0 x le -3)-[la-n55 + Pla) (0 bated growth path, we ned © [og +8)-[(@-Dsy + pens )]-0 “There arto pores Dex =-8 and 2) eg = Bln 0)/1-e) “The phase diagram implied by equation (7} is spiced at ight Equation (7) yes an ‘nvered parabola wath these wo rots We an see tha gc* = Bn + (0-0) iea sable tance? growth path while gy = 8 snsable “To ottin the growth rate of ouput onthe balanced growth path subttatethe value of gy ska equation a ¥_ odin) Bila + 2) + Blo) aims) ¥" (=a) Ime or sinply Y oF {From guation (9), Y/Y willbe pstive so hr wil be parmana roth in cup. Is lo posible {come up with 2 coin on some ofthe parameter which ensure tnt ouput pr person is aso song a postive rate onthe balanced sews pth, For eat ofan, define y= 1 - Probe che Shoe of ouput wh respect lind Th Bone) Ire" Bey here thet sep earanging a +B+9= 1 oreplace 1 =. Fue singh (Vit) _ pia 2-10 wa Bry Bry Sfx patie oh in pet pope et seve 20 or -m>0 or poten ree Pe-rn>d eF ‘Thus the bigger is g (the higher the grown rate of technology), the bigger is (the more important effective inbor is in production), the smaller i (he less porte aad st the production process) and ‘he smaller is a (the smaller the population growth rate), he more ky for here to be permanene ‘rowth in curs per person. Basically, lhouph the sock of land i fed at long 2s technology Improving fast enough, a5 leg a land i nt oo mportnt n the prodction proces and 3 long a6 he umber of people in the economy snot sing too quickly, the sim amour of land canbe used ina more 7 Productive way an the economy can experience long-run growth fom De ere, Problem 111 ‘The production function wat captal-augmenting technological protess is given by12 ‘Satons to Chapter 1 @) Yee =[Acn Ken] Ley Diving ba sides of piston (1) by AL) vil vo {awk FT te OF Lawn! [ROMO] and spi vith Fa OK orp uo dhs fey xe _xo AO" H0 LAF | Now, defining $ = o/(1 ~ a), k(t) = K(tWACt)*L(t) and y(t) « Y(QWvA()*L(Q) yields: @ wo-Ko aoa}: to Ain) ATED F In order o analyze the dynamics of K(), take thet derivative ofboth sides of Ki) = KIQ/AG LA) eg HOLA? Le =Keolen [aot Lol? Kok fA, to] AmtLa am La LAG "Le, and then using kit) « K(Q/AQ)*L(), A(O)/A(t) = w and L(t)/L(t) = yields: ©) ke =K0/AOFLED=GutKO The oli ft tla ok by thus @ koe 3K Subang qn (to) ges ie Kee = <7(0/Ae*L(Q) -8KE/ ACO LD — (hu + mIRC = sy) — GH D+ THC) Faly, ug uation 2) ~ 0) = Kt)" ~ we have () KQD=ski0)* ~ Gun FHKE Equation (5) is very sma tothe basic equation g2vering the dynamics ofthe Solow med wah Tabor augmenting ecological prepress. Here, however, everything im ants of AOL) rather than units of efetve labo, ALA, Using the re praphial technique a wih the basic Solow mes, we can graph bo components of k(t), See he diagram at nek When actual nvesement por unit of ACL) ~ sk)" ~ excad breakeven investment er unt OF AWLE)= (hu tn + IK) — wl vse towards "When actual investment pe unt of -M()L(D fas shor of break-even investment urn okey ky = KOA Solutions to Chapter | per wit of A()*L), k il fall towards k*. The econcny wil converge to a suation where kis constant cK* ignore the possibly that thesia lvl iki er). Since y=, y wil also be constant when the economy converges tok ‘The teal capital tock, K, can be writen 35 A'LK. Thus when ki constant, K wl be growing a he consane rat of bu +. Silly, teal oupu,Y, can bewnttn as AML. Thus when ys constant, loupetsrws a the constant ate of hu +n aswel, Since Land A grow a constant ates by aeSumpric, wre have found a balanced growh path where allthevarables ofthe movel grow at constant ates, ) The production action snow gen by (6) Y= HQ? Lee) Define J(t) = J4t)/A(t). ‘The production function can then be written as: core |*uo"* Proceed as in part (a). Divide both sides of equation (7) by A(t)” L(t) and simplify to obtain: vo fio 2) Lae 9 J Now ening = a(t a), (0 = Te)/ACOL) and yo) = YOVACOMLAD yes: & x0=50% ‘In order to analyze the dynamics of j(t), take the time derivative of both sides of j(t) = T(t) /AW)*L(0: Fi9{a00* Lay] -Teo[paco* ACU) + LAC] [acoPue Sot fa to} Aore@ ae@tu@ Paw” Le) and then using J(t) = TONAL, ACO/AC 00) jo=feo/ae* Le Gu mKo and Ley/Lee) viel: The ner spi opt an expen for Fit, Tak the tine devative of bat sides of T= J/AC) io JOAO=IOAD HO AL JO. Ca CORT) Now sie) # HO/A(), ACD/AG) = ad it sAOYO BND 10° x a NO «snp An 10 =110-G 90 Sabu eqation (1) negation (10) Ho =sVin/ACor Le) 4+ dT0/ A LO) =n “OH Feslhasag oman ©) ~ 0 = (0 —we have 12) jt) = 51) =[n+ 8 + Cl + O9)7000 singe same graphical etmque a with he base Slow motel we can graph bath component of it) LA()Y() 8108) to obtain 0 =[a45 ena reo1“ 0 Chapter | Sethe ingram at sight, Ts eomomy © vel ecovegetoa sation were | it estan a" Grog te possibly tha the nti eve j= 0). Since y= 5° yw ao be cnsane when he ‘conaiy converesto 3" for8oet e950 sto" The level of oa output, Y, can be writen as AtLy. Thu whan y is ensant, ope grows atthe constant ate | oon By definition, T= AL}. Once the ronomy converges tothe situation where 3 ss constant, J grows a the constant rate of fp-ta, Since J= J+A, the effective capital tock, }, grows at rate gun jor simply n+ HCl + 4) Th the economy does converge toa balanced growth path wire al the variables of the mode are ‘rowing at constant rates and dus fom equation (12): ©) On the balanced growth path, j¢t) FP eslnss-rn01+0)) HFaforseeo =F and us 3) jr [yas no) Subttate eatin (1) sequin (9) ean expression for ott per i of NL) ote balned gre pa [sfln+5+ wave) “abe he derivative of)" wi espero ae feif is peers 1 _} @ Lica! lavseuneo] [averwaal In order totum this toa slaty, kip bt se by owing he exes for fm gute G5 on the nga side re oe fells PHT 1 ow @ yr linal |e | irererier i esrerice i} singin ye att {a Vnsdeniea ls] ay lines Slaveratioa) and thus finaly. Solutions to Chapter! 15 6) A fiscorder Tair approxination of § around te bled romps value of y=" wl bof te feo 09) 50/5 Taking these deave ob eof eqn) le a 5-355 Saute eto (12) sain 17) [58 —(a+8+ nds Oi) 8) y=s0}*" =o) foods 14] . . Euston (18) expresses j inte of} We can expat J a termeafy sce y= 3°, we en te Jay Ths dy ey eal 9 spre by ei A i SB TL fata nj8D a2 Hasse nae] fz a [alow | Le | U Mle J som, 99s simply j!"since y= J and thas: Baap REP gia css ycle gi eae 0} fm + H+] hae Finally, substi out fers by rearanging equation (13) 0 oben #= [a +5-+ ll +4) and tus x Ia454 ule gyi2e—DiT ola +d-+ +4) ox sing a9 a -c1-aifard+nc +o) Please Substituting equation (19) ino equation (16) ives the fender Taylor expansion (20) y2-t1-aylnrd+ uCi+d)}-fy-¥"] Solving this lft equation ae nthe ext) yes Qd yi yee eH 0-9] “This means that the economy moves fasion (1 -a) (a+ 8 wl 6)] ofthe remaining distance towards yy each ye. The eaten of pat wt respect tos th same inthis vel inthe asc Solow model The Saad of comernoce i fae’ nemo, ln te basic Solow model e eof cavern Ben bY Gayla 5 whereas ths motel ais (1 -ab{n 8H» 6) wich is rene sine @ wai) Yeablem 112 2 The rom acouning techniques of Seton .7 yield he allowing epesion forthe ro te oF pat pr pose: obey Yo" te [ko Leo] Lk@ Leo! x +R)16 Solutions to Chater 1 hore a () i the elasticity ofcurpetwih espe to copa a timet and RG) isthe Solow resid [Now image appying this growdh-acounting equation t 3 Solow economy that in ke Slane growth path, On the Balanced growth path, he prow rates of aurput per worker an capa per worker ate beh ‘sual othe growth rte of A” Thus equation (1) ample at growth accounting would arbte fraction ck of growth in ouput per worker growth i eaptal per worker, It would abut the ert fraction 1 ~ax ~to technological popes, 2 this s what would be eR i the Solow vesidal. So with our sual estimate of ax = 13, growth accounting would siibute about 67% ofthe growth in ue pot ‘worker to tchaolgtal progres and abut 33% ofthe growth in ouput per worker to groweh a capital per worker: ') Inan accounting sess, the resuk in par (a) would be tus, btn dope sense it would not the ‘eason thatthe captal-lbor rato grows stat othe balanced greweh path is because the efecveness of labors growing at rae g. That i the growth in he effectiveness of labor ~ the growth in A~ rates cuput per worker trough two chanel Fis, by directly raising output but als by (fra given saving rat) increasing the resources devoted to capal accumulation and thereby rising the eaptal labor rao Grow accounting atributes the rien output per worke through the second channel to growth i the ‘xprallbor rato, and no to ts undeiyng source. Thu, athough growth aceousting i of isu ‘1s not appropriate to wterpret it ae Shon igh on he underiying determinants of proveh eoblem 113 8) OLS wil yc a bins etimate of the slope coeficent ofa regsesson if the explanatory variable i ‘omlated withthe ror term, Weare given at © Hf gH gl 24 ef 8 E 2) lg) =2[(¥) 59) hore aid are assumed tobe uncorelated wih each ther and withthe tre unobservable 1870 income er person vanabl, [CN el Subsitng equation (2) ot (1) ad eran yells ©) tl (7), yp9] iV") go] 2 +b- tl), ex) le Ruin a 15 reo ms ©) wi ye ised onto b(n corte wh Seerertem f-'+bu pu) one dw conser’ te ene er Shans ocacmie be ec (UADin a we gate tse Howes meses wee vabecth=-h dential @hisspiye Th OLS ee soe ane Senta ei wig bcd i ete om b) Measuresien error in the depend variable willatcauze a problem for OLS estimation and is, in fac, one ofthe ustiiations for the dturbance term 8 regression mode! nutively, f the measorement ‘orn 1870 income ge capita), the exlanatery variable, here wil bea bias towards fodng onvergence. 1F1870 income is overstated, growth is understated. Tis looks like convergence 2 “high" intial ncome country growing slowly. Sirulty, f 1870 income is understate, growth is overatd, “Ths also locks lke convergence ~2 "Tow" ital income country growing aul. Solutions to Chapter | 17 rote insta tis ony 1979 income ger cpt) bjt to rnd, mea ro measurement rer, Wien 197 acon overated sis goth fora piven evel of 1870 came, When 1979 cane SSundested, so growth fra given 1670 meome. ser ase equally ely = overstng 1979 tex fo any gue 187 inn uly wdesing (rere rely, eae Tor San sverge seal os), Tir the roo eto roel cee Wo se moro se enrages the realy ih iSOLUTIONS TO CHAPTER? Problem 24 Dy the fs problem isto choose the quantities of apa, K, and effective labor, AL order f0 Psomze coms WAL 41K ~ subj tobe poducen funcion, Y= ALA), Se up te Lagrangian WwAL + [¥~ ALFR/AL)] “he fsx conics ae pve by er -afAL-OK/AL) VAL] =0 raw @ ee Som lrasnvenerovat caer] =o = wealtan-1-F00} 2) Ding eatin 1 by ion o tf =" Wk FO) Equation (3) implicitly defines the cost minimising choice of k_ Cle this choice does net depend pen. tbe level of utp, ¥_ Note that equatioe (3) is the standard cor-mnimizing concition whichis that the ‘ato of the marginal cost ofthe two inputs, captal and elective labor, must eqal the ato of the argue product ofthe two put 1) Since shown in part () each firm chooses the same value af kad since we are tld that each firme ‘hs the same value of A, we can wie the total amount produced by the N cor minimizing firms as By, Eaneay=aray $1, « abr “where Tis the total amount of labor employed. “The single firm also asthe same valve of A and woud chose the sme value of ~ the choice of k dos te dopenl on Y-Thus if osed all ofthe labor employed bythe N eas-rniizing ims, the ingle fe would produce ¥ = AL{(}). This s exacythe same amount of curt produce i tal bythe N coxemunmizing fms. rablem 22 5) The nda’ problem eto maximize Limo uly given by cet Get Typ 1-8 subject tothe lifetime budget constraint given by @) PC. + PGW ‘re W repress lifetime income. Rearrange the budget conti 0 8 Cs ©) Gy=WiPs Cy Pi Ps Stlstute equation (3) toga (1: chy fw, cy-F/Py]* ale isp 0 ‘ow we an Sle te unconstrained problem of maxing ily ~ as given by equation 4) ~ with reopen tort prod consumption, The fstordr conten 69 by Soluionsto Chapter? 19 20 fey =r lung) co? (-%)=0 > CF=lytse (Ra) ce cx snot 65) Cy ={1+ (Py /P))"" Cy Inder t solve for Cube eatin (i equation). Co= W/Ps (146) -( 2/01)! Co-[P/Pa) => Calte(t+o}¥® (Pa/m)” awry oe spl wiry (ram) el Fall to get theeptinal coe of Cy, subset oust (6) no equation (3) (i+ of" (Pa m)"* (wir) 2) From equstion (the optinal ati offi pid to second peri consumption i (8) C,/Cy =(1+9)"* (2 /R1)* alin th og of both ies of equation (8 yl (9) tel Cy /Cp} {1/8} tal + pl +18) ol /2,) “Te lsc of eubttvtin betwen Cr C,~ defined in such way tat ti pave ~ ven by Aci /C2) (P2/P) altn(CriCa)] _ a AP, /%1) (Cy/Ca) ” afta(/e;)] © where the last tep ses uation (9) find the sive. Thus higher values of 8 ply that the Indivdsal ste willing to ebute consump brween pend Problem 2.3 ‘We need o solve the houshokts problem keeping everthing in pr cap tem rather than ia units of effcive labor and assuming log wily The housdol's problem isto maximize Lfeuneublay subjecto ‘he budget constraint. Thats, problem st maumize Ten uo a us Teminc®, oy us Temncentt subject 2) Te Bg Mg KO. F ARQ meg t® oe eure ue ‘AWOwOE KO) ni Le Now in Wa BO, F eRe at ews Pat ‘We can use the formal metho, presented ete text, for sling this type of problem Set up the Lagrangian uw 4] Fe Rica OH Fence Maer) 4 ue mews ae af “The frs-order condition enbySolutions to Chapter 2 rey LO, 1" he 1 ° ect) coy conseye yt GB) eC) ne RO nn meee en Sc ung nmi ene o Temofenct a0] WO gy sect -e U0, asp -1 HO) 7, (9) LO Fook wy ort os Aslngas 22> 0 (sich mt bo hte gto Ip -8) and th given by: raggenn Submsing eqn (ot eqn 0 ys (8) Cc =e | _W p~n} co lear (e-*)| tna cosa there ‘Nate that C(0) is ensumyion pe person, W i wealth per housdold and LOVE isthe numberof people er household, Thus W/{L(O)/E] i wea per person. This equation say that mal consumption pet evs is constastfactioo of intial wealth per person, and(p-a) canbe interpreted a the marginal ropensty to consume ot of wealth. With lgartunc tly, his prepeasity to consume is independent of the path of the real iter ate Also ate that the bigger i the houses dscoant rate p —the more the housthld discounts the frre ~ the bigger isthe fraction of wen that intlly consumes Problem 24 ‘The housaboli's problem sto maximize lft wiley subject tothe budget constrain. That is problem sto maximize Fa cot? Ley ue Tee Oe LoD Ot eH subjects 0 Tee new 2 ue corre we W detest ln wth pl te ps al fine ana th Tetons ep 3) tc mtr nl et ed co ‘tesanetenStmal cho pnd ite igs pean See Domne Fn Moa, 7 Solutions to Chapter? 21 1x-orecondion te by Oe ote yn HO ecw Oe caning he LO is 6) eC P= he Ditto ses of ut (wth eet ie: © [-0c1y Eee] - pe MCU? + rhe =0 ‘This an be erranged to cbr me ee ee ee 9 aE ‘Thus with a constant eal erst te, th growth te of consumption sa censtant. Ur > p ~ thats if the ae atthe marke pays to defer consumption exceds the houshol's discount rate ~ eousurgtion| val tenisng overtime. ‘The vale of dermines how fst consumption will grow ifs exceeds p. Lover Value of @ ~ and thus higher valuse of the laity of substation, 1/8 — mans that consumption growth nl be higher for any given difference between nd, ‘We now need to solve forthe pth of C0, Fist, ace that equation (5) ean be rewriten as Be, a) Imogateequstion (6) forward mine «= Oto ne tax =inceoy «fle ee} ih spies to © w{cv0/c10} =[(r- le Taking te exponential fncin of bah sides of eqn (7) yi cence =ell 9 sedis © C4 =Cioy-e14I Wear now sive fornia consrtion, 1), by wingthe it atk must be chown to say he howsaoids budge consvant, Subainde ein (8 a equation) Femexoellaltl Ly aye Tete “ Using theft Lt (ye yields: (0) LDLOD Fort a y w22 Solutions Chapter 2 As log as [9-1 + 6(¢-))0> 0, we ean solve the negra on) ycellsale, [lon 2) coy ropailses Problem 25 2) The equation describing the dynamics ofthe capital stock pe nit of fete labor i A) et) = ACO} - (8) = C+ BKC For s given k, the level ofthat ini k= Oe given by €= Rk) => gk Thus fling makes the level of eeosisent with k= 0 hiher fora given k. That, the f= 0 cuve sits yp. Inukively a lover fakes break~evn investment lower at any given kand thus allows fr mare esouoes to be devetad to onsumjtion and sill maintain a given k- Sine (2+ ek fll propersonstaly more a higher levels of, the k=O curve sit up more at higher levels Fk. Sethe diagram. 2) Toe ition dri th amis of stunt er of ese teri by econ “8 “Thr cnc required for ¢=0 gem by £€)=p +85 Arse in gf) muse wea cite 20" Soce "(9s aeave lc eae he nec hr ses Ths 20 cove sits toe ©) Atthe time ofthe change i the Value of k= the tock ofeapial per unit of effective labor =i given by history ofthe eesnomy, and eannct change ‘Escontinuusly. romans equal tte eon the old balanced growth pth In contrat, ©~ the rate a which household ae consuming in nts of ‘ffetve labor ~ can jump at he tine of the shock. In order ford economy 19 ach the new balanced growth path, ¢ st jump athe stant ofthe change 50 thatthe economy onthe now sade ah However, we cant tll wheter he new sad path pases above or below the xginal pot E, Thus we Cannot tll whether cmp up oF down ad s ae ~Fthe new sade path passes nght hough pow E~ Sotaions to Chapter 2 ‘might even msi he same athe stan that g fills Theres er, cand ke gradually to their new balaicedroush-path values; thee ae higher an ther values n he orgs balanced growth path 4) On balanced growth pth the fraction of utp that enved nd invested given by Uf") ~e*) AK), Since is canta, or k=O on a balanced growth path hen ~ from equation (1) ~ we can wate ft) -cF = (a gh. Us this, we can rewnte te fracicn of eutput that is saved ona balaiced growth pat a: @) s=[e=sryM) Differenuating bot sds of equation (3) wath espact tog ss Gea + eX Ck * og) +k) (at ge PTA OW ee which simplifies to (oy 28 OBES) FOCI) ee ray? Since ks defined by £4") =p + Og, differeniaing bth sides ofthis expression gives us "XE 8. Solving for ery gives ue (©) Beleq= OG) <0 ‘Subsututing equatin (6) nt equation (5) ves oy oe a BME) ke P= REDE AY es TROP Fe) “The fis term in the numerator ie postive, while the soond i negative ands he sgn of is ambiguoor ‘Thur we canner tll whether the fll m grat or lowers the saving rte onthe ne blanca srowth pth 2) When the production function it Cobb-Douglas, £8) =k, () = ak and £08) = ala - 1% Substinting these facts into equation (1) yields Be (ne gike® -ktake™ Ne rk ke ala oy Ha BABIis’ “heehee aK usta oe Fala Dk which simplifies to (25 _(org)k** (1 a)8- (= aye ak 28 (-0-ak which implies: (i 2 ng 28 =o) es (mre) ‘Thos, rally, we have pee? ° Problem 2.6 Theres eatin of maton: ¢) 2. fA Fs a S sed) L(= FAO) - e+ KIO)24 Solutions o Chapter 2 3) Ansein 8, Thisisa fallin the elastiny of substrution - 1 ~which means that people became less nilingo substnneconsugtion bere pesods. Iso meaas thatthe maepizal wily of consumption falls off more apy ae consumgtion izes fhe economy i rowing, ths tends to make howsehoas ‘ale present consumption more tan fire consump ‘The copa accumulation equation i unafeted, ‘The concn requted for =O ie gen by £0 9+ 0g. Sine F"(k) <0, the Fh) dat makes €1 0 iow higher Thus he value of that satis =O ie loner, The &= 0 locus SiR tothe le Th exmomy moves upto point A nthe new sade path — people cosume more now. Movement itm down slong the new saddle pai utile economy reaches poi E At that point, c* and kare lowe thn their original values 1) A downward sit ofthe production inti. ‘Wecan assume tat this means for any given k, Bath) and "(are lower than before, ‘The condition requir fork 0s given by € Fk) (a+ g)k. We can see fom the right diagram tht te ‘older-ek willbe over than before Thus the k= 0 lacus hie ae depicted ithe diagram ‘The contion roqied for €= Os given by Pk) = +O. Fora gren kf") isnow lower Thus we needa ewer kt kop the same ad satsy the ¢= 0 equation Thus the €= 0 locus ahi let, The ‘sconce wll eventually ach pont E" with lower ead lower kt Whater cially jumps up o down ‘rpm won whether te new Sade pth pastes above of Below pint E locus wil shift down mote at higher levels of Alto, since fora given k, f° (is lower now, the Solutonsto Chapter? 28 ) Apostive rate of depreciation. “Tae new eapitl-accumultion equation (0) Hee) = URC) ~e€)-o+ B+ RC) “Te eve of saving and investrneraquired just to keep any given k constant it now higher ~ and thus the mount of consumption posible nvr lower = than i the case with no depreciation, The evel of exra invement required i also hiherahgherevls oF k. Thus the k= O locus shifts dowm more a higher levels of nado, the real reun on capitals now Fk) = 8 and so the household's maximization wil yield 0 POR) 8-9-0 08 = ‘Tee condton required for €=0 is F(K) =5+ p88. Compared tothe case wth no deprecation, () sear be hiher and K lower i order for ¢= 0, Thus the €=0 locus shits tothe lf. The economy will retualy windup at pot "wth lower lavels of cand. Agaia, whether c jumps up or down iially ‘pends upon whether the new sale pth pastes above ot below the engaal equlibrum pot of . lem 2. i ‘Wiha portve depreciation rate ~8 > 0 ~ the Euler equation andthe apt accumulation equation are som by a) _ FRO) -8-p-85 ay £0 eo) Spr a ee os ; ad @) Ki We egin by taking frstoder Taylor approximations to (1) and 2) around k= KY and e=e*. Thats, we (ko) =) (a8 +8)Kt0 & & a &, © es S pepe Bene bz % fends He-e4} ) Seer Si ad) ke fk SE he 88 0k, 2 Oe, Dk/Sk and Ok /de areal evaluated at k= and e= e+ Sincectand kt are constants, © and ate equvalant 9 ¢ =e and k=* respectively. We can Uerfrerewrte (3) and (2) 3826 Soins to Chapes 2 Fiennes Stee & ze Using equations (1) an (2) to compas tese den oe Tee ee Fk) ~bp=be “eo © lege ® a al @ 8 =r0)-o+8+9 a Se loop Blea Sbstiting equations (7) and (8) int (5) and equations () and (10) ico (6) yes Parje" OE cs 8 irr) —(ore-+6)} kk ee) toate seo secre =plk-Ke)=le~e4] “The second ine of equation (12) uss the fact at (2) implies hat f° ‘the definition of Bas p-n~ (1-8. ane (02) kk p0g The third line uses Dividing equation (11) by (€~<%) and dividing equation (12) by Ok") iets: Coen Pt er hake tke ee Cale=e sage ilen(enes recent eve eee rca ga dcaenetntesahe tn sco mer 09 bee and Now consider the Cobb-Dowga production fin — A) 4. Ths (16) £(k*) mak Ort and (a7) F(kt) =a(a~ Dk From equation (16) sang es (8) (445)? ak also equa (7)can be sevens) wre 1 qa? ok O and U"(e)<0, In adition, since the expected value of Yi qual toe, wecanwnte ¥;= Ys t € wa E10) =0 Solwtions to Chapter? 35 2 The india pb io choose Cy and Cy oder to maximise UIC) ~ UC) sb to: OG 0- 0G 0-0) We ean soba for Cyan save he unconstrained problem of choosing Cy ‘rax UCC))+ E[UlO= 4p) -C, +0 4% #0 ‘he irs-ode condone by: Vic + EU, x-D] =0 x snaly @ UC)=EUCs)] {Fie inavidual optimisng, th marginal tity of coneuretion in pend | must ois te expected arpa wy of consump pried 2. by IFYs nt rnd, the fet order condsin redvessta U(C\) = (Ca). Wah UE) <0 evenrbere, ts imelns ht C= Ce. iy i guna then U" (Cerin C. Using te hint ~ [U'%C)}= U{E(C)] ~ te fester condn given by equation (2) canbe revriten at V(C)= ULECCs)). Since U°()<0 everywhere, this implies that Cy = E(C)) Now, U"()>0, (0) <0 and U" (9 >0. Marga wily istow a ces acon of ansumpion 2 so by Jenene EUCCa)]> UfECC:)] Combing this with frsvorer canon ~ U(Cy)=E[U%Ca)] ~ yes LIC) VIE]. See U()> 04nd U") 0, he india! undertakes £2) The goverment ic curing ft peiod axes (2) and raising scond-peiod taxes (im Each a way that, eect ax revenue remains unchanged. Expected tax revenue, R, canbe expressed Vit t2 EY) ee)= R. Using the fat that Ee) = 0, wo ean solve fort avenyek = Ryn In order to keep F constant, the change in taxes mst sais ) ea /éy=-1 ‘The questions whether or at ths change nthe ing of taes ars the aus consumption beaver Susie equate (I) eto the rcordr conden ~ ego (2) to obtain @ VE ELU[A=4)¥, -C, «0-H, <0] Ditters beth sides of equation wrth spect ol: UHC) eC, fee, = ELUUCI-Vs 204/201 OH, +02 and now wens equstion @) ~ 2 1 awoke VC) -2C, fe, = FLUTE IY = eC4/20, +¥5 re] UC) 2 ee, = E[UUCa)-[-€C fem} + FLUC). [Ue + efu-eCay]} ec, jer, = ELUC.)-«]Solutions to Chapter 2 Now as the fa: tht fr any two random variables X and Y, ECKY) = EQOECY) + cow(X.¥) vc) +H UC2)]}-2€; jee) =F[UUC.)] Ele sco UrtCare) Finally (6) = 0 and ths th change in fist-penodconsuprion ds to this change ia the ining of tones ig sive by __ corfu} wep-eUren) ©) FY: se random then «= 0 always and thus the covananc inthe numerator of equation (5) i 0. ta addon if walt qusdratc, then "(a eaasart and again the covariance sO In both ofthese ‘ies 2C; /ory =O and thus firs period consumption does nochange in response othe tan exe 8) Inthe case of U"(0)> Owe needto show that 2 /ér) <0. That is, we need to show that Cy nse in tpnse tothe rection in, Inuively the ihe se the bigher wil be Cy The individ spy ‘onsurncy any ext random income nthe second pn If U" («) > then ap Cartes so mill (en), and ths & willbe the case that covfU" (Co}> 0, The denominator of equate (3) wl be negative ssce "(<0 and hus 06/2 <0 as required. The enution is thatthe change in Ue timing of tes leaves {he individual wih the same expected after ax fete ince, but more oft comes with certany inthe Sis period tbe incivavals doing precationary saving ~ fU"(e)>O she the amount of uch saving will be reduced and she will eonsume more inthe ts period 1) The CRRA uty fincon ad its fist two derivatives ae given by wo=c*/a-3 = VIQ=C% = UC~-3e™ and di: UIO=-0-8-C7P* = 74/020 fero>0 Thus the CRRA unity Function does imply the preauionary saving behavior desrbed above Problem 213 Equation (2.61) inthe text describes the rlatonship between kes and ki the special case of logarithmic vali and Cobb-Douglas predation Ta naky* «Dk Grease Tap OWE" = Phe 26) kes Solutions to Chapter? 37 than t woul have been in che absence ofthe increas in population growth andthue capital per ait of {flee labor in period +1 is Lower fora giver 'b) With the parameter B added to te Cobb-Dousas production funtion ~ Rk) = Bk" —eqution (2.61) 0 kit *Gpmdaw Tap Co eB ee (0 koa = Tanta) Zee This fallin B causes the ky faction to shift down, See the diagram from pata. A lower B means tht 2 ‘ven amount of cpital per unto effective labor in period now produces less carpet pr uit of eect Inborm period, Since the fraction ofthc abo income thatthe young save doesnot depend on Bhs leads to less ttl saving and 2 lower capital stock per unt of effective labor in period +! for 3 given ©) Wenoud to determine the efit on kn fora given ofa change in a. From equation (2.61): ky 1 ui ax] 4h =, | 4 (1a: oft carl oe | Seon du Bey oa @) Aaftay/éa nk, Now note that we can write io) 2), fla) dia 2a Bink) oa and thus finaly () aac» fain, Therefore, we have "ba Fey __ insta) [emnayiara] ee lnk. Subst his ft into equation (2) yields: 2)? ky 2a” Grayiee) tee cor simply fee [a-epink, — Tramp To fee took, Thus, fo (I~ a)lnk-1>0, oF nk, > VC ~a), an ncaa in mane higher lo for 3 given ky and thas the ks fimction shits up over hi range of y's. However, for lnk = Ii(I~a), an increase no means 3 lower a fora given k Thus th key function shits down over ths range of k's. Fall ght st 'ak,= 11-2), the od ad new ha Functions intersect. Problem 2.14 2) We ned to find an expression forks 26 function of, Nox period's capital stock is eu to this Penods capital tock pus any investment doe this period las any depreciation that occurs, Thut ) Kae Kyee¥,-3K, To conver this into units of efeive labor, divide bth sides of equation (1) by Ais Keg Kell8)48Y) Ky) Ky(-8) + fky) Arabia Avalis (eas gyAib +ayl +e) tie gest ants _j, fs Omarp | lasmare38 Solutions to Chaps 2 1b) We na to sketch he a. function of ky sk.) “Gemare ky) 20 and ‘Trodsp ‘Lomita ) and using he ats cones a, a, tim 2a jim R18 sb “ay wu ak, Geen) “Thus the fnction eventually has a slope of less than 1 and wil therefore rose 45 degree line a some pout Also, the fancon swell iehaved and wil crssthe 4S degre line oly coc, ‘As jong ask starts outa sane valve ther han 0, he ‘conomy wil eomvergeto i". For example, ik stated ‘ut teow et, we se tht wl be greater than I nd the cconcmy wil move worardsk*. Sully. if ‘Sars out above *, we ace that fs wl be bol land again the econamy will move towards K™ At, "= Akt) iv also constant and we have a balanced ‘row path ©) Ona ularcod prow path has =e ndshas rom egution ice : < feed Irae lacmacel Vaswae ee Fienegeng—148) f 5 1 otha basa near Bee in ron etal pont ree tae Sei Saab poet ty cee) Oo am eon acgsarOh he pe een Pe amis crmnyia pent fee td Tegan 0 pr pe eee ene wy ng+8)] need) | Solutions to Cupter2 39 43) Subsite» Cobb-Dovelasprodvtion function ~ fk) wel fs Grease larmare = into equation) sel oka 4) Ona balanced growth path, 1 Thas from equation (8) vie el lasaate! “larmaa! Sinplifjn yes : - fasmi-p-0-9}, [shoe azmise |" lavexire sd dus ally (0) r= [olla gong +5)" i) Using equation ( Sal, 18 ~ ak Inge OF AMIFD Gem re Suttuing the blaned-rowt path ale of kt ~ equation (9) ~ nto eatin (10) ik Sal Tore+ne+8)] ay hae Gomde) Oemtow willbe wel towne (a+ ng +6) 56 (1 0K +6) -(1-3) 00) 18 a aka] _ (-8)+af(lemtieg) 0-8) ah Neate CesT) Sinpliing forber yields as 0-0-0 aw OO Bela Or® Replacing eqition (8) by fst Taylor approniticn around k= (2) yg BR slastt-aja-ayfemer~a [ee] See we can wet thie smply as: += 891/01 9)0+ 9) fg] qui (12) pls. (8) k= uk 3M ay/c1+ y+ gi ko] ‘Tos the economy moves fraction I= [a+ (1 8){1=a)/(V+n)(+g)] ofthe way tote balanced gromth ‘ah ech paiog. Some sample algebra simplifies the expression for is rae of convergence to (mayinsgeng=d)/Urn+ 8 With a = 3,1 = 1%, = 2% and 8= 3%, this ved arate ofconvermence of= 3.9%. This is simlar but slower than the ate of onvergence found nthe conumuoue tine Solow mods.40 Soltions to Chapter 2 Problem 215 2) The individ opamization problem not affcted by the depreciation which mean hat ‘= £0) =5. Tae hoveholds problem ssl to manne ty ie subject the budget canara . © Ce Ca = Avy Asin th text — with a depreciation —the faction of income saved, ses) = (U-Cy, DAM gan by i 8) s3)®——gt— eee ede a+ Tha te nay in ch he actn fica saved deeds nthe ear fs, ican “hw oly tec ta helmet slic Os) rae an st Os) Thera gach apnedtI eu Se aout yoy aivauts mpenot ar @keosts sere th moat of eig de bya yun esi pil, Nath sw the Shoat saving coe welt te faci fone sve ns he meu toscana eatin (Gea te ewrin ©) Rese tosten ‘geist ftet + thane be eb fern) les i Arstbest Arabia Esea-ma] Soce Ul epi wehae Ahn =U) Silty fle = #9), Inada, Rovian eh a 0) hig = sad © bea aaa ew Fly, baie fr sf Q)- Bad m= A) bef) er 6) bya 8}. (ea =r t40] hoa etre Latha [= yF) “This scl be cpa wth equicn 260 he ten ~ the nla exresicn with no depreciation eros 1 , aay Mr fy ero} “Thus adding deprecation des alter the relationship between kn and. Whster ks wil be higher or lower fora given ke depends on how saving ares with ov kia © angi ye ae i po bem i a Beit haere 00) bea em ook} eaten mn tant pin de ST ey Solutions to Chapter? 41 “qe saving tte inthis esonomy is txal saving divided by total carp, Note that hii nt the are at TT) hich s simply the fraction of tha aboriacome tat the young save. Denote the economy's ttl HegkiNeas § Then # wal equal he soving ofthe young pls the desovng of theo all dvded by fel ouput and we can do hiss n unt of eecuve labor ‘re sving ofthe young i [/(2+p]-(1~a)-k,2, Sine teres 100% depreciation, theo do nt get to rave by the amount ofthe capita stock ~ thee two dsavng by he old Thus Has) O-e)-k* 1 ay Ke “Tee “Thus equation (10) can be writen a8. 1 2 0) es bn >| ley 0) ke Tha “laeware Note hat this is exactly the same asthe expresion for ka a incon of, inthe dere Solow redel wih 8 =|. That, is equivalent o equation (2) n Problem 214 with et to 1. Thus that ‘ernon ofthe Solow model does have some microeconomic foundations, aldhough te assumption of 100% recite ie gute unrealistic. eblem 26 2) PayrkeVeu-Go Social Scary 3 Th ety ncn sie by 0) tay, +L pl] tn Ca0t ‘Wate oil ear tx of T pr pein, niviua fcshe lowing cons (wh the pow ate of ecology ~oqalt00, A's Sng) contat houphow) Burs =Am-T © Cais C4 aS +0407 hee §, orcs the india saving he pod. Asi 25th indivi is concerned, he rate feu on soil secre (+8), wich genera i et be equal he eam on priate saving ichigo) Brom aquton G), + a)St=Cayss (Lm), Seving for Sys: oy 5, = S21 tb) OS Tia Otte Now subst ution (0) quate 2): cig Bh aw, Te Fer OU OF ty Rearanging, we gr the intertemporal budget constr: (eu =9) Medes) ehnow ta mh oer ily, the indivi wl ensue acon (t+ p+ poe ie ‘wea inte fe ped. Ths, Seale (reels Tote fran per perien subst equaton (ino eaaton 2)Solutions Chapter 2 free) (tu =2'h Gasp) tizah fe =Li2- law + 0 S1=[Ml2 eld | aoe) Nowe that if or =n, saving ruc one-frone bythe rota eeurty tx, Hy > 0, sing flee than oe fore. Feallyy ify, saving fall ore ta ene rn Denate 2, = [2+ pt +r) (1+ PNG ~0]/2+ pL) and hs equation 7) Becomes 5, =| allaw, 2.7 Ie il tue thatthe capa tock period wl be gual tthe tal saving ofthe young in eid hence O) Key" Site Ceavertog this nto units of efctve labor by dividing bat sides of) by ALer and wing eatin 8) yrds 29) Kear =[YC0-+ al] [(YO+ ed) - 27/4] Wiha Cobb-Douglas production fiction the el wage i ve by- a wade Subsiing (1) so (10) gives te new relaiship between cepa prod + 1 and captain eri, Ail ius of effective aber (12) Keg =[1/(1+a)] (yop) aye ~2, T/A] 3) Tos what effete inaction of th sc sey syste has nh alae growth vee fe we mas dtrmie he of I poste te ntoducen of he nT, Su dome Pe en une and edees Oe talancat grove pu orf So nehaad =e PNtar a) ele pX1+1))~ (pts “md Gs exis) @rpMena singling fete allowe aston Z ener s(rpfds a) Cas-al] Wane 0-20 G+ Kirn) Grp na “Tht, the as care sis Gown = bie othe cse wot he socal scr = and i duce 20 i) the economy is intially dynamically efcet marginal increas in T resuks in 2 gain othe old generation who receive the extra benefits. However, reves k further below koe and th leaves Eure ‘snerations worse of, eth lower conzumpten posible. Ifthe economy was mally dynamical Inefficient ~s0 that k* > hoy =the old geeratcn aga gains veto the extra benefits, Now, the reduction sn k* actualy allows for higher consumption for future generations and is welfaresimproving The Introduction of the tx im this case reduees or may possibly elimmnate the dynamic neffceney caused by ‘the over-acramulation of capital ') Fully-Fandd Social Security 2) Equation (3) becomes: 09 Cae) =O aS +02 HIT |As far asthe individual is concerned, the rate of eur co sci sect the same as that on private saving We an now derive die eteremporal badge constraint, From eiston (16) Soluionst0 Chapter? 43 049) $= Cora /(lt nai) T Sosnuting equation (14) equation 2 els ¢: Cute ihe aw ret ersimely 0) Gur ean “is ijt eempol bgt courant rend ma, Shing envi tounaien pods bul Es eons Cop01 = [Yl al) Cera) Ciy Subsining his no he bags enrique (15) — yl 00) Gir =[e 020A, “Toget saving pr pr, size eunion 15) a euin 2) Sp = Awy =[[1+ o}/{2+ jaw, = ox siny 7 §, =[Yl2+ pl]Aw, -T ‘Te ssl ery tx ses ne fone oan in pit ing ‘Te capa stock in period +1 wil be qual othe sum of ttl private saving of the young pls the etal mount invest by the goveramen, hence 8) Ker= 5). TL Dividing both sites of (18) by AL, to conver thi ito unt of fective laber, and uring equation (17) pelt ; Ly) olpayer ws -(ea} ape eR) ich implies to ews =[YOra)-[Y[2+ 0-7 Usiog enation (11 subse rhe wage ys 19) Kaa = [Yd] [y(2-+ pl] epee Thus the flyin sos system as no fet nthe eles betwee heap ck ete pres 1) Stace there iso efet onthe relationshipbarten ky and, te balanced-growh path value of kis the same as i was before the muoduction ofthe fully funded seta eecary yam. (Nee that we have been assuming that the amount of he ax i ot pester than the amour of sang each individual would have done inthe abeence ofthe tax). The basic ea is that tual invesueat and saving ssl the same ‘ch period ~ the goveramentssiply doing some ofthe savng forthe young, Suce socal secuny pays the same rate of cum as private saving, india are iiferet ao who does the sang, Thus ‘ndividualsoffct one-for-one any saving that he government does fr the, Problem 2.17 4) ln he decescalied equilibrium, there wil be no iexgeneratinal ade. Even ifthe young woud like ‘otrade goods this period for goods next peciod the only peopl around to trade wth ae the ol, Uaforsunately, theo wil be ead ~ and tus no poten fo complet the trade ~ net ped,44 Solutions to Chapter 2 “he indvidat sey Action gen by. (Gee aC ae The consis ar Qqehed ad) Cyn erh ere Fis the soi ted bythe nda Substring equation () wo 2) elds te enemporl ode constant Ci Caaf ‘The nda proba to maximise ifime ula ~ ae gn by uation (1) ~ bjt tothe smenenpora but contrat ~ as gen by euaion(). Setup te Lagann Anta +ICapai MA~Cip ~ Capes] ‘The fonder contin are given by ee/eie=VCp-d0 > YC=2 24/240)“ WCaqu)~Wa=O > YC Subse equation () ato oqo (6 and rans oan O Cntr Subetiae equtin (7) to the intertemporal bugs conaaint~ equation (4) ~ to obain Cuetxtha/e or spy @ Cy=ar “To olan an exresion fr secondperiod consumyric, substitute equation (8) nto equation (7) Cry xa?2 ‘When young, ech vidal consumes half of her endowment ad stores the cher half ~ thai, € = 12 This allows hero consume xA/2 when old. Note that with log wlity, the faction of het endowment that ‘he invidal stores does n0t depend upon the eta to soap £) Whats ons er ni of cv abr at ie Fis, elt consumption atime C=C re Ne ether aN, young nd ld pole alive aint, Each oun person consumes the faction of ther endowment thy donor sare (1 DA wil ech of person gets tceatme he gon ery cnn facon of eeu ta ey ord “BA, Thus Geen AN tA Ney To omer tists f tine efve Ibo, ide bth sides by AN ae Cyfan, =-8= Ay] “Thus case pr nt of tine fice aor isa weight average of 1 and sarge han 1, sce x(1 1), wl hrfore ba mannizd when te weg on 1 that when f= 0. (You coud Aso ss for canst er pre lv a tine which wel oc hae fe rer her), ‘Tee decmerlized equiltrium, with f= 12, in Pte efficent Since intargeneatoel trade not posible, people areforeat” nto storage bocaure thatthe only way they ca save and consume m old age. They must do this even ifthe retum on storage, is low However, at any point in time, a socal Planner could ake Tuna from each young person angie (I) und to each od person since there are fewer ofthe. Wa (I -n)>x this pers beter rum than rage Thetefoe, te socal planner could ‘air wife by taking the al ofeach generation's endowment tht they were going to sore and mead {geesttothe old. The planner could then do his each period Thi allows people to sl ensue A/2 wnt Solio to Chapter? 45 shea young and now (1 *n)A/2 its when ld. This is geater chan the xA/2 units of consumption when (Boe they would have had nthe decenralizad equa with storage Problem 2.8 Te ndvidal haem ley function given by Gy ey tC ast sd constants pressed in units of money ~ given by @) PiCi = PA- PR ME ©) PuaCaset = Prareh ME whee M3 iz nominal money demand and Fis the amount stored ‘one way of thinking about the problem eth following, The individual has wo decisions to make, The fat sto desde how much of her endowment o concur and how much te "sae Thon she must decide Howto save. through storage, by hlding money ora eombinati of bath. Wa log uty, we can pate the two decisions since the rte of retum on “ating” wil nt aft he faction ofthe fist peiod evowment tats saved From Problem 2.17, we know she will onsume bal ofthe endowment in the frst ered, regadlese ofthe rate of return ca money o storage, Thus: C22 Wha does she do withthe other half? That will doped upon the gross rate of ret on storage x ~ relsave tothe gross rate of return on money, which sP/Pay. It is PP since the individual ean sil 1 tne of consumption n period and get Punts of money. Tn period ¢ +1, ene unt of consumption costs rasan of money and thut one wit of many wll bay 1/1 units of consumption, Thus the individuals ute of money sl buy het P/P., unts of eonsumpacn in period +1 CASE Lx P,P She wn consume half of her endowment, sore the ret and not hold any money since the até of eur en mony ie es than the rate of retum on sage, Thus Cusaa Raa? MER =0 Coy aA/2 CASED: xP, /Pe Now storage s domunated by holding money. She wil consume half fer endowment and then sll the 1 for money Cy sar 0 ME/P=A2 Cori [P/F [6/2] CASE 3: x= P,P Money ad storage pay the same rt of tum. She will consume half of her endowment andi then indie a8 to how much ofthe ter halfto ore and how much of to sl or money. Leto € {0,1} be the fasten of saving that isin the form of money. Thus: Cysaj2 F=d-aa2 ME =xaj2=[P./Pial-{A2] 1) Eauitbrium equives that aggregate real menay demand equal aggregate real monty supply ‘Wecan derive expressions for both rel money demand and supply in pid ¢ ‘regate rel money demand = N, [4/2]46 Solitons o Chapter? agree ren money spy = [No t+ )}4/2 [s+ 94/8 “uv expression for arate rest mene sry wt the fc tht m prod 0 ech peren ~ andthe ae Noy 2 often = ecves Muon of more. Th a sep chen tse fc at since population grows arate, Nr= +0) Na and har Ny= A 2 can te ue equim end ole or Ns Niden"yf, > Remyfaden"] ‘ec smitty dre express fore one oranda spy pid + aggregate real money demand = N,,y -[A/2] = (l+n)-N, -[A/2] aggregate real money supply = [Ny /(+0)'"]M/Pyas ‘Wecan ten uth equa anton the fr deoyne-[Aal=[Ne/on"M/es > Ray=2nfaasny?] © Dividing qin 6) yeni (3) ys RaleMileny a Pia /On) “Tas mails feral tine prods 2 and oP. #8) a equim. Ths howe ati ‘nays ocr into jialy ef econ rege en be mated, Te ey cul wl seam taunt oft arr’ aug. Se pele 2 17spa {Sean cplnaon af hy ere orge matin conanpin pe at of ecu abr ©) Ths eth station where , oa =X ~the ret oo money i ql tothe etm on rage tn thi ‘se individuals re differen gt how mich ofthe saving to store ard how mich o had the fom ‘ot manny. Let ye [0,1] Bethe faction of svinghld nthe frm of money in period. We ca again enw expressions for aggregate ral money demand 38 supply in pened ad] ssgregate ral moey suply = [No (+ ]s4/2 = [N/m] 4/2, ‘We can then ue the equim condition to save for P Nealaa]-[Nocra' M/A, = R=2M/fa,aa+n""} 0) aggregate real money demand ‘We ean smilary drive expressions for real mont aggregate real money demand = Nj. -@43[A/2] demand and spy period + +9) Ne eal A/2] aggregate real money supply = [Nc /(-+ 891} ‘We ean thn wet euibriu candtio to save oP (+n) -No oa A/2} =| [0-209 Diving equation (8) by (7) yes: Prar/Pr = [ero] [YO] For Pe P= Le, we nee foedesu)-[ycemp=tix > [aser/ae]=[x/tin)] 0 is equivalent tox=Q,/ Qe forall t> 0, ln cher words, the rate of eu (on storage is equal tothe at of eum en trading and hence the india is nee sto how muchto store and how mach to trade. Let cy € (0, 1) represent the facicn of savng",A2, hat the indvidual tells m pened t Thais, the individsal sels 2 (A/2) in period Tis allows the individal to buy the ‘mount, (Q,/Qes KAR) when they ae olds period t+ 1. The anvadual tres a faction (1-2) of er Seaway” Thos 8) S=(-, AR) ‘Consumption in period +1 wil be equal to he amour he india buys plus the amount they have through storage. Thus (8) Cans = 04 (QQ: KAD) + (1 3,996 02) Since ve are considering a case where Q, Qui" x, equation (5) canbe rewrten 35 = a, x(A2) = (1 ay (AL2) = (422) ‘ som period t+ 1 and let N represen the total number of individuals bom each ped, which i somstant. Aggregate supply in period «+ 1 equal to he taal number of young dvds, N, mahi by teamount tat each young individual uncer to al, x (A/2). Thus 8 Aegregate Supplies = Now (A2) ‘Aggregate demand n period t+ 1 sequal tothe total numberof dnd, N, mu ‘mount each ol individual wishes to buy, (Q,/Qey Ja, (AL2). Thos ( Atgregate Demands = NCQ, Ques (AM2)