VCREME K30-31

March-2019
MACROECONOMICS
2 hours. Open book exam

I. Consider the Solow model in continuous time where the rate of technical
progress gA and population growth rate gL are both positive. The parameters
of the model are given by saving rate s and depreciation rate δ. The production
function is
Y = K 1/4 (AL)3/4
1) Prove that, at steady state,

s = (δ + gA + gL )k 1/4

where k is capital per effective worker (k = K/AL).

2) Derive the expression for consumption per effective worker c = C/AL.
Which is the value of s that maximises the level of consumption per effective
worker?
3) Show graphically what happens if there is an increase in the rate of
technological progress. What will be the effects on the rates of growth of output,
per capita output and output per effective worker?
4) Now suppose that gA = 0.02, gL = 0.05, s = 0.2 and δ = 0.01.Compute the
steady state values of capital per effective worker, output per effective worker ,
growth rate of total product. Find the salary and the gross return of capital ?
What is the ”golden rule” level of capital stock k g for this economy. If we wish
to obtain k = k g in the steady state, what is the associated saving rate sg that
must be imposed by the social planner to support k g ?
II. Consider the problem
∫∞
max e−rt ln C(t)dt
0

such that
√
K̇(t) = A K(t) − C(t)
K0 = K(0), KT = K(T )given.

where the constant A and r are positive. Here K(t) and C(t) are capital
stock and consumption at time t.
1. Prove that if K ∗ (t) > 0 and C ∗ (t) > 0 solve the problem then

A
Ċ ∗ = C ∗ [ √ − r].
2 K∗

1
 2. Suppose that A = 2 and r = 0.05, prove that the equilibrium (in steady-
state) is a saddle point.
3. Draw a phase diagram of the system.

III. Consider the following model

∞
∑
max β t ln ct
ct ,kt+1
t=0

such that

ct + kt+1 ≤ (1 − τ )Aktα + Tt
ct ≥ 0, kt ≥ 0
k0 > 0given.

where τ is a flat rate of income taxes and Tt is a lump-sum transfer. Agent

maximize his utility by taking government policy (τ, Tt ) as given, and A > 0, 0 <
α < 1, 0 < β < 1.
1) Using Bellman equation, show that optimal solutions satisfy
ct+1
= (1 − τ )βαAkt+1
α−1
.
ct
2) The government budget is balanced so ct + kt+1 = Aktα . The saving rate
s is determined as ct = (1 − s)Aktα . Find s ?
3) Find the steady state levels of capital and consumption.
4) Show that the tax rate has a negative effects on the saving rate and
steady-state level of capital.