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