Volker Hahn, Fuzhen Wang University of Konstanz

Advanced Macroeconomics I, WT 2012/13

Exam
Date: 9 April 2013, 10:00 - 11:30

You may answer in English only.

The duration of the exam is 90 minutes.
Please use only the designated white sheets for your answers.
You must not use any books, notes, etc.
If you use mathematical formulae, define the respective vari-
ables (unless the variables have been defined in the question).
Problem #1:
Various issues (15 points)
(a) Suppose that different countries are described by the steady
state of the Solow model and have identical growth rates
of technology (g) and population (n) and identical deprecia-
tion rates . How can you explain differences in GDP across
countries? Recall that, in the notation used in the lecture,
 1
 1
k = n+g+ng+
s
. Moreover, explain the term growth ac-
counting. (3 points)
(b) In the Solow model, the production function satisfies Inada con-
ditions: lim FK (AL, K) = 0, lim FK (AL, K) = . Explain
K K0
these two conditions in words. (1 point)
(c) Modern macroeconomics emphasizes microfoundations. What
are the main features of a microfounded model? (2 points)
(d) Explain the terms level effect and growth effect. (2 points)
(e) Give an intuitive interpretation of the natural debt limit.
(2 points)
(f) Explain the meaning of Ricardian Equivalence in detail.
(2 points)
(g) What is the difference between the neoclassical growth model
(= the Ramsey-Kass-Koopmans model) and the AK model?
Do these models permit growth in per-capita GDP without
technological progress and for a constant population? Explain.
(3 points)

Problem #2:
Consider a simplified version of the neoclassical growth model with
infinite-horizon. As usual, we assume a Cobb-Douglas production
function and CRRA utility. That is, F (K, AL) = K (AL)1 with
c1 1
(0, 1) and u(c) = with > 0. (0, 1) is the discount
1
factor. Capital depreciates at rate (0, 1). The economy admits
a representative household. There is no population growth and no
technological progress. The single good can be used as capital or
for consumption. (21 points in total)

2
 K F (K, AL)
(a) We define k = and f (k) = . Please derive
AL AL
the equation governing the evolution of capital in terms of
intensive-form variables. (2 points)
(b) State the social planners problem sequentially. (1.5 points)
(c) Formulate the social planners problem recursively. (1.5 points)
(d) Write down the equations that characterize the social optimum.
You dont have to compute the social optimum. (3 points)
(e) Dynamic programming proves powerful in dealing with infinite-
horizon optimization problem. Please give an intuitive inter-
pretation of the idea of dynamic programming. (2 points)
(f) Define operator T by T V (kt ) = max {u(ct ) + V (kt+1 )} for
kt+1 (kt )
the social planners problem, where V () is the value function
and () is the set of admissible values for the control variable
for a given value of the state variable. How could you verify that
T is a contraction? Explain in detail. (All standard assump-
tions such as completeness are fulfilled so that you do not need
to worry about mathematical rigor). The contraction mapping
theorem suggests a useful algorithm for value function approx-
imation. Please describe the analytical version. (4 points)
(g) Now we leave the social planners problem and move on to the
competitive equilibrium analysis. For the economy under con-
sideration, each consumer is endowed with 1 unit of labor which
he supplies inelastically. Capital is owned by the household. A
representative firm, which is owned by the household, hires la-
bor and rents capital to produce the consumption good. In the
following, we adopt the date-0 trading structure. Please formu-
late the households problem and the firms problem precisely.
(5 points)
(h) Give a precise definition of the competitive equilibrium in terms
of the prices and quantities that you defined above. (2 points)