Sample Final Exam

Exercise 1

Solution: a. Since y = B(1 )k , thenY = B(1 )K L1 , and K = sY = sB(1 )K L1 .

k=

( K ) L t

KL L2

LK = L2

1 1

K L

nk =

sB(1 )K L1 L

kn = sB(1 )k nk

In the steady-state: k = 0, then k = sB(1 ) . One can note that n b. B = ( k ) = k .

k

< 0.

k = sB(1 )k nk = s k (1 )k nk = s (1 )k (1+) nk . Note that since < 1 , then 1+ < 1+ 1 and (1 + ) < 1 + 1 = 1 k =
s (1 ) n = 1

c.

. One can note that k < 0 , then the economy reaches the balanced growth path immedi

1 1(1+)

ately: k = s (1 ) n. k To have a non-negative growth rate we need to have s (1 ) n.

+1 k d. max k = max s (1 ) n ,
k k

= s 1 ( + 1)
1 1

= 0,

. If we compare e. If = 0, then B = 1, in that case k = s(1 ) n this result with the one in point c where k keeps growing at a constant rate, then obviously corruption leads to a signicant (innitesimally large) reduction in k (since in point c k approaches innity when t ).
Exercise 2

Solution: ct+1 a.ct+1 = (wt ct ) (1 + rt+1 ), ct + 1+rt+1 = wt

ct+1 1 t+1 We maximizeU (ct , ct+1 ) = ct + 1+ 1 with respect to ct + 1+rt+1 = wt 1 After we rearrange rst order conditions, we get:
1

c1

or

c t c t+1

1+rt+1 1+ 1+rt+1 1+
1

ct+1 =

ct
1 1 .

We use ct+1 =
ct = st =
wt
1 1+ 1+r t+1

1+rt+1 1+
1+rt+1 1+

ct and the budget constraint to derive

b. Take = 1, then
St wt

wt Ct wt

=1

1 1 1+ 1+

1 2+

1 This implies a logarithmic utility function U (ct , ct+1 ) = log (ct )+ 1+ log (ct+1 ) c.Nt+1 kt+1 = st Nt wt , divide both sides of this expression over/Nt . Since there is no population growth, then Nt = Nt+1 , and then kt+1 = st wt . 1 Since wt = f (kt ) f (kt )kt = kt kt kt = (1 ) kt , we have kt+1 = (1) kt . 2+

In the steady-state kt+1 = kt , so k = 1 2+ d. Since st is a constant, there is no eect from the rt+1 side (and thus, from any tax on rt+1 as well). e. Instead of kt+1 = st wt from point c we have kt+1 = st (1 wt ) wt now. Then kt+1 = k wt < 0.
Exercise 3
(1)(1wt ) kt 2+

1 1

, and in the steady-state k =

(1)(1wt ) 2+

1 1

Solution: y2 c2 a. c1 + 1+r = y1 + 1+r b. We solve the maximization problem, derive FOCs, we rearrange FOCs to get: c2 1+r c1 = 1+ .
1+r We use c2 = 1+ and the budget constraint to derive c1 = c1 c. Borrower: c1 > y1 , y y1 + 2 or, knowing that c1 = 1+ 1+r : 1
2 y1 + 1+r 1 1+ 1+ y

or

y1 +
y2 1+r

y2 1+r

> y1 +

y1 1+

1+

>

y1 1+

d. Borrowers: cB y1 = 1

Lenders:y1 cL = ; 1 Since there are no external borrowings and lending, and the number of borrowers is equal toythe number of lenders, then y y y or
2 1 1+r 1+1 1 1+ 1+ 1

y2 y1 1+r 1+1 1 1+ 1+ 1 y1 y2 1+2 1+r 1 1+ 1+ 2

=
y2

1 1+2

2 1+r 2

1 1+ 1+

r=

1 2+ 1+ 1

1 ++ 1+ y 1

2 2

e. From point c we know that d to substitute for r:

1+

y1 1+2

1 1+ 1+ 1

1 + 1+

1 1+ 1+

1.
y2 1+r

>

y1 1+1

, and we use our result from point

or

y2 1 1 ++ y2 2+ 1+1 1+2 y1 y1 1 1 1+ + 1+ 1+2 1+1 1+1 1+2

> )
1

y1 1+

or

1+2 +1+1 +2 2(1+1 )(1+2 )+1+2 +1+1

>

1 1+1 1+2 1+1

1 + 2 + 1 + 1 + 2 > 2 (1 + 2 ) + 1 +

or

(2 1 ) 1 +

1 1+1

< 0, which is true, since 1 > 2 .