Matthew Bonino

Macroeconomic Analysis
Econ 301-Spring 2019
Homework 5
Due: April 30th in class

1. Page 209 Problems and Applications question number 5

5. Consider an economy with the following Cobb–Douglas production function: Y =

(5*K^1/3)*(L^2/3).

a. Derive the equation describing labor demand in this economy as a function of the real

wage and the capital stock. (Hint: Review Chapter 3.)

Labor Demand Equation

MPL = W
dY/dL = W
5 * (2/3) * (K/L)^1/3 = W
10*(K/L)^1/3 = 3W
b. The economy has 27,000 units of capital and a labor force of 1,000 workers. Assuming

that factor prices adjust to equilibrate supply and demand, calculate the real wage, total output,

and the total amount earned by workers.

Total Output
Y = 5 * (27,000)^1/3 * (1,000)^2/3
= 5 * 30 * 100
Y = 15,000

Real Wage
 10 * (K/L)^1/3 = 3W
10 * (27,000/1,000)^1/3 = 3W
10 * 3 = 3W
W=10

Total Amount Earned By Workers

W * L = 10 * 1,000 = 10,000
c. Now suppose that Congress, concerned about the welfare of the working class, passes a

law setting a minimum wage that is 10 percent above the equilibrium wage you derived in part

(b). Assuming that Congress cannot dictate how many workers are hired at the mandated wage,

what are the effects of this law? Specifically, calculate what happens to the real wage,

employment, output, and the total amount earned by workers.

Real Wage
10 * 1.1 = 11
Employment
3 * 10 * 1.1 = 10 * (K/L)^1/3
3.3 = (K/L)^1/3
(K/L) = 35.937
L = K / 35.937
= 27,000 / 35.937
= 751.31
Total Output
Y = 5 * (27,000)^1/3 * (751.31)^2/3
= 5 * 30 * 82.64
= 12,396.69
Total Amount Earned By Workers
W * L = 11 * 751.31
= 8,264.41
 The raise in minimum wage causes employment to fall, total output to fall, and total
amount earned by workers to fall.
d. Does Congress succeed in its goal of helping the working class? Explain.

Although the lesser amount of people employed will be earning 10% more, the

working class overall will suffer because the total amount earned by all workers decreases

significantly.

e. Do you think that this analysis provides a good way of thinking about a minimum

wage law? Why or why not?

Yes, I think this analysis provides a meaningful way to think about the minimum

wage law because even though a slight increase or decrease in the wage might not seem like

much, it can have drastic change on the total output and total amount earned by workers.

2. Page 239 Problems and Applications question number 1.

Country A and country B both have the production function Y = F(K, L) = K^1/3*L^2/3.

a. Does this production function have constant returns to scale? Explain.

Yes, this production function does provide constant returns to scale because when

capital and labor are multiplied by lambda, the output is also multiplied by the same

lambda. Given the same proportion increases, the function provides constant returns to

scale.

b. What is the per-worker production function, y = f(k)?

Y = K^1/3*L^2/3
Y/L = (K^1/3*L^2/3)/L
 Y/L = (K^1/3)/L^1-2/3
Y/L = (K^1/3)/L^1/3
Y=K^1/3
c. Assume that neither country experiences population growth or technological progress

and that 20 percent of capital depreciates each year. Assume further that country A saves 10

percent of output each year and country B saves 30 percent of output each year. Using your

answer from part (b) and the steady-state condition that investment equals depreciation, find the

steady-state level of capital per worker for each country. Then find the steady-state levels of

income per worker and consumption per worker.

o= depreciation rate = 0.2

sA= savings rate in country A = 0.1
sB= savings rate in country B = 0.3
Y= k^1/3 = per worker production function

Steady state condition

k=k* such that s(k*)^1/3=o•k*
= k* = (s /o)^3/2
Country A steady state capital
k*A= (sA / o)^3/2
= (0.1 / 0.2)^1.5
= 0.354
Country B steady state capital
k*B= (sB / o)^3/2
= (0.3 / 0.2)^1.5
= 1.837

Steady state income per worker

y*= (k*)^1/3
 Country A steady state income
y*A = (.354)^1/3
= .707
Country B steady state income
y*B = (1.837)^1/3
= 1.225

Steady state consumption per worker

c*= (1-s)•y*
Country A steady state consumption
c*A= (1-0.1)*(0.707)
=0.636
Country B steady state consumption
c*B= (1-0.3)*(1.225)
=0.858
d. Suppose that both countries start off with a capital stock per worker of 1. What are the

levels of income per worker and consumption per worker?

k*A = k*B = 1
sA = .1
sB = .3
o= .2
Steady state income per worker
y*= (k*)^1/3
Country A steady state income
y*A = (1)^1/3
=1
Country B steady state income
y*B = (1)^1/3
=1
 Steady state consumption per worker
c*= (1-s)•y*
Country A steady state consumption
c*A= (1-0.1)*(1)
=0.9
Country B steady state consumption
c*B= (1-0.3)*(1)
=0.7
e. Remembering that the change in the capital stock is investment less depreciation, use a

calculator (or, better yet, a computer spreadsheet) to show how the capital stock per worker will

evolve over time in both countries. For each year, calculate income per worker and consumption

per worker. How many years will it be before the consumption in country B is higher than the

consumption in country A?

Country A

Year k*A y c i sK Change in

capital
1 1.000 1.000 0.900 0.100 0.200 -0.100
2 0.900 0.965 0.869 0.097 0.180 -0.083
3 0.817 0.935 0.841 0.093 0.163 -0.070
4 0.747 0.907 0.817 0.091 0.149 -0.059
5 0.688 0.883 0.795 0.088 0.138 -0.049
6 0.639 0.861 0.775 0.086 0.128 -0.042
Country B

Year k*B y c i sK Change in

capital
1 1.000 1.000 0.700 0.300 0.200 0.100
2 1.100 1.032 0.723 0.310 0.220 0.090
3 1.190 1.060 0.742 0.318 0.238 0.080
4 1.270 1.083 0.758 0.325 0.254 0.071
5 1.341 1.103 0.772 0.331 0.268 0.063
6 1.403 1.120 0.784 0.336 0.281 0.055
 From the two charts, we can see that it will take 6 years for the consumption in

Country B to exceed the consumption in Country A.

3. Page 239 Problems and Applications question number 3.

Consider an economy described by the production function: Y = F(K, L) = K^0.4*L^0.6.

a. What is the per-worker production function?

Y = K^.4*L^.6
Y/L = (K^.4*L^.6)/L
Y/L = (K^.4)/L^1-.6
Y/L = (K^.4)/L^.4
Y=K^.4
b. Assuming no population growth or technological progress, find the steady-state capital stock

per worker, output per worker, and consumption per worker as a function of the saving rate and

the depreciation rate.

Steady state capital stock per worker

s(k)^.4 = Sk
(k)^.6 = s/S
k = (s/S)^1/.6
k = (s/S)^1.667
Steady state output per worker
y= [(s/S)^1/.6]^.4
= (s/S)^.4/.6
= (s/S)^.667
Steady state consumption per worker
c = (1-s)*k^.4
c. Assume that the depreciation rate is 15 percent per year. Make a table showing steadystate

capital per worker, output per worker, and consumption per worker for saving rates of 0 percent,

10 percent, 20 percent, 30 percent, and so on. (You might find it easiest to use a computer

spreadsheet.) What saving rate maximizes output per worker? What saving rate maximizes

consumption per worker?

s k y c
0 0 0 0
0.1 0.509 0.763 0.687
0.2 1.615 1.211 0.969
0.3 3.175 1.587 1.111
0.4 5.128 1.923 1.154
0.5 7.438 2.231 1.116
0.6 10.080 2.520 1.008
0.7 13.033 2.793 0.838
0.8 16.281 3.053 0.611
0.9 19.813 3.302 0.330
1 23.616 3.542 0.000
The output per worker (y) is maximized when the savings rate is 100%. The consumption

per worker ( c ) is maximized when the savings rate is 40%.

d. Use information from Chapter 3 to find the marginal product of capital. Add to your table

from part (c) the marginal product of capital net of depreciation for each of the saving rates.

What does your table show about the relationship between the net marginal product of capital

and steady-state consumption?

s k y c MPK
0 0 0 0
0.1 0.509 0.763 0.687 0.450
0.2 1.615 1.211 0.969 0.150
0.3 3.175 1.587 1.111 0.050
0.4 5.128 1.923 1.154 0.000
0.5 7.438 2.231 1.116 -0.030
0.6 10.080 2.520 1.008 -0.050
0.7 13.033 2.793 0.838 -0.064
0.8 16.281 3.053 0.611 -0.075
0.9 19.813 3.302 0.330 -0.083
1 23.616 3.542 0.000 -0.090
When the savings rate is at 40%, the marginal product of capital is at 0 which means it is at

maximum efficiency. The consumption per worker is also maximized at the savings rate of

40%.

4. Page 239 Problems and Applications question number 5.

Draw a well-labeled graph that illustrates the steady state of the Solow model with population

growth. Use the graph to find what happens to steady-state capital per worker and income per

worker in response to each of the following exogenous changes.

a. A change in consumer preferences increases the saving rate.

Separate page attached to back. 4A.

b. A change in weather patterns increases the depreciation rate.

Separate page attached to back. 4B.

c. Better birth-control methods reduce the rate of population growth.

Separate page attached to back. 4C.

d. A one-time, permanent improvement in technology increases the amount of output that can be

produced from any given amount of capital and labor.

Separate page attached to back. 4D.

5. Page 267 Problems and Applications question number 1.

Suppose an economy described by the Solow model has the following production function: Y =

K^½*(LE)^1/2.

a. For this economy, what is f(k)?

k= capital per worker

f(k)= output per worker
Y = K^½*(LE)^½
Y/LE = (K^½*(LE)^½)/LE
y= f(k) = k^½
b. Use your answer to part (a) to solve for the steady-state value of y as a function of s, n, g, and

o.

Δk= sy-(o+n+g)k
0= sk^½-(o+n+g)k
sk^½= (o+n+g)k
S/(o+n+g)=k/k^½
k^1//2= s/(o+n+g)
y= s/(o+n+g)
c. Two neighboring economies have the above production function, but they have different

parameter values. Atlantis has a saving rate of 28 percent and a population growth rate of 1

percent per year. Xanadu has a saving rate of 10 percent and a population growth rate of 4

percent per year. In both countries, g = 0.02 and o = 0.04. Find the steady-state value of y for

each country.

Steady state value of y for Atlantis

y= s/(o+n+g)
y=.28/(.04+(-.02)+.01)
y=.28/.03
y= 9.333
Steady state value of y for Xanadu
y= s/(o+n+g)
y=.1/(.04+(-.02)+.04)
y=.1/.06
y= 1.667