University of North Texas

Econ 5330 Macroeconomics Theory: Assignment Two

1. The Ramsey-Cass-Koopmans Model. There are L people (total
labor) and H identical households. The number of people in a household is thus
L=H. Population grows at rate of n:Subjective time discount rate is denoted
by . Consumption of each person is denoted by C.The household divides its
income (from the labour and capital it supplies) at each point in time between
consumption and saving so as to maximise its lifetime utility.
max U tility =

Z1

U (C)

Lt
dt
H

t=0

s.t.

It
Kt
Lt
Lt
+
= Rt
+ Wt
H
H
H
H
(1). Rewrite the problem in intensive form (i.e., in per eective labor terms);
(2). Write down the rst order conditions;
(3). Write down the dynamics equation for consumption per eective labor
and that for capital per eective labor;
(4). Using a phase diagram, analyze the dynamic eects of increasing the
degree of impatience for an economy which starts o in period 0 in the steadystate corresponding to the old, lower .
Ct

2. Overlapping Generations Model. Assume that Nt identical individuals are born in each period t: generation tand each person is endowed with
At units of productivity enhancing knowledge. Population of the young grows
at a constant rate n: Thus, Nt = (1 + n) Nt 1 for all t. Technology grows at
a constant rate g. Thus, At = (1 + g)At 1 . Each individual lives only for 2
periods. There are two generations alive in each period: the young (Nt ) and
the old (Nt 1 ). The individual has preferences over consumption when young
and when old. In particular, we assume
U (c1t ; c2t+1 ) =

1
C1t
1

1
1+

1
C2t+1
;
1

(1)

where > 0 is the inverse of the elasticity of intertemporal substitution (or the
risk aversion coe cient) and > 0 is the discount factor.
In period t, the individual is young and supplies one unit of labour (or,
equivalently, At units of eective labour) inelastically, for which he receives a
wage income wt per each unit of eective labour. The individual decides how to
allocate his income between consumption C1t and savings St :In period t + 1, the
individual is old and does not work. The individual can use the principal and
interest rate (1 + rt+1 ) St from his savings to buy consumption goods C2t+1 .

(1). Write down the intertemporal (lifetime) budget constraint faced by an

individual born at time t;
(2). Use the budget constraint and the individuals utility function to solve
for rst period consumption C1t , and rst period savings St .
(3). Determine the relationship between kt+1 and kt and graph it.
(4). Find the golden rule level of capital and the steady level of capital.
(5). Using the results from part 4 of this question, explain why dynamic
ine ciency may happen? Give two ways to overcome dynamic ine ciency.
3. AK Model. Production function is given as follows
Yt = AKt , where A > 0 is a constant.
Assume there is no depreciation , i.e., = 0. Number of households in the
_
economy is H = 1. Population growth rate: L(t)=L(t)
= n. Per capita capital
stock: k(t) = K(t)=L(t). Per capita consumption: c(t) = C(t)=L(t). Utility of
the household
Z 1
U=
e t u C~ (t) L (t) dt;
t=0

where u C~ =

~1

C
1

> 0. Budget constraint of the household:

C(t) + I(t) = R(t)K(t)

(1). Rewrite the problem in per capita terms;

(2). Set up the Hamiltonian equations and derive the rst order conditions;
(3). Write down the dynamics equation for consumption per eective labor
and that for capital per eective labor;
(4). Solve for k(t); c(t), and y(t);
(5). Compute the growth rate in steady state. Intuitively explain why the
economy can grow even without technological progress.

4. The Lucas (1988) Human Capital Model: There are two sector
model, where the physical capital is still produced with the same technology
as the consumption good, but human capital is produced from the education
sector. For the education sector, each individual has one unit of time per period
that he can use either to work or to go to school. In the school, the individual
acquires education, more human capital and becomes more productive. The
level of human capital h(t) of the individual evolves as follows
h_ (t) =

[1

v (t)] h (t) ,

where 1 v (t) is the fraction of time in school (v(t) is the fraction of time
working) and > 0 measures the eectiveness of schooling.
Production function is given as follows
Y (t) = K(t) N (t)1

; N (t) = h(t)v(t)L(t)
2

Number of households is normalized to be 1.

We assume that there is no growth in population, n = 0. Population is
normalized to be 1, L = 1. Capital does not depreciates, = 0. For notational
purpose, we introduce the following notations. Consumption expenditure of
~
a household: C(t) = C(t);
Returns from capital of a household: R(t)K(t);
Labor income of a household: W (t)v(t)h(t); Investment for future capital (asset
_
accumulation) of a household: I(t) = K(t).
The household chooses consumption and time spent working to maximize
his welfare subject to his budget constraints and initial and terminal condition.
The population growth modied households problem is given as
max

tC

(t)
1

t=0

dt;

subject to
h_ (t)
K_ (t)

[1

v (t)] h (t) ;

= R (t) K (t) + W (t)v(t)h(t)

C(t):

(1). Write down the current value Hamiltonian;

(2). Write down rst order conditions;
(3). Solve for the dynamic equations for C(t), W (t), h(t), and K(t) respectively.
(4). Compute the growth rate in steady state.
(5). Intuitively explain why the economy can grow even without technological progress.

5. Real Bisiness Cycle Model. We consider an economy with xed labor

supply (i.e., we can normalize L = 1)
"1
#
X
t
max E
u(Ct )
t=0

subject to

Yt

ln At+1

At Kt = Ct + It = Ct + Kt+1
ln At + (1

) ln A + "t+1

(1

) Kt

(2)
(3)

where the log of the technology shock (At ) is assumed to be an AR(1) process
around the steady state A (normalize A = 1) and "t+1 is iid normal variable
with mean 0 and variance ! 2 . All other variable are dened as usual.
(1). Write down the Lagrangian equation;
(2). Solve for the rst order conditions;
(3). Assume that u(Ct ) = ln Ct and = 100%. Solve for Kt+1 and Ct , and
express them in log form.

(4). Solve for the variance of ct , kt+1 and at , where ct = ln Ct , kt = ln Kt+1

and at = ln At . Compare the results with stylized facts listed in the lecture, do
you think if this model is successful in explaining business cycles?
(5) Compare this model with the model presented in Question 1 and explain
intuitively why this model is capable of generating short-run uctuations.