Macroeconomics I

Problem Set # 2

This is due Thursday 26th January.

Exercise # 1: The Solow model with productivity growth

This exercise consists of analyzing the standard Solow model studied in class but assuming
productivity growth. We assume the following production function:

F (Kt , At Lt ) = Ktα (At Lt )1−α

where:

L̇t
=n
Lt
Ȧt
=g
At

(a) Write down the two fundamental equations of the model

(b) Write down these two equations in per capita terms. Use the following notation for
per capita terms:

K Y
k≡ y≡
L L
(c) Take the equation for the capital accumulation in per capita terms. What condition
must be satisfied in steady state? In other words, at which rate must k grow? and
y?

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 (d) Use the rate at which k grows together with the capital accumulation equation in
per capital terms to calculate the value of kt in steady state: kt∗

(e) Get back to the two fundamental equations written in (a) and write them in per
capita efficiency unit terms. Use the following notation for per capita efficiency
units:

K Y
k̃ ≡ ỹ ≡
AL AL
(f) Take the equation for the capital accumulation in per capita efficiency units. What
condition must be satisfied in steady state? In other words, at which rate must k̃
grow? and ỹ?

(g) Use this condition together with the capital accumulation equation to find the steady
state level of k̃: k̃ ∗

(h) Imagine that a shock to the savings technology of a country (think for instance on
an improvement in the banking system) increases its savings rate s by 5%. What
would be the percentage change in k˜∗ ?

(i) Describe the evolution of growth of k̃t along the transition towards the new steady
state

Exercise # 2: The Speed of convergence in the Solow model

This exercise’s aim is to understand how fast countries converge to their steady state. In
the Solow version of the model that we have studied above, we know that the equation
for the rate of growth of capital per efficiency units of labor is:

k̃˙t f˜(k̃t )
γk̃,t = =s − (g + δ + n)
k̃t k̃t

Let’s define the speed of convergence as:

dγk̃,t
β≡−
dlnk̃t
which measures how much the growth rate declines as the capital stock increases in a
proportional sense.

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 α
(a) Assume a Cobb-Douglas production function so f˜(k̃t ) = k̃t . Obtain an expression
for β. Is it increasing or decreasing in the value of k̃t

HINTS:

• Use the Cobb-Douglas production function to leave γk̃,t as a function of k̃t and
parameters (s, δ, n, g)
• Since you need to differentiate γk̃,t with respect to lnk̃t , make use of the basic
property eln(x) = x to find an expression of γk̃,t which depends on lnk̃t
• Once you have taken the differential of γk̃,t with respect to lnk̃t , use the same
basic property to get an expression that depends only on k̃t , s and α.

(b) Assume that the current level of k̃t is below its steady state k˜∗ Does β depend
positively or negatively on k̃t ? Provide the intuition.

(c) For this part of the exercise you can use a calculator, excel, etc. Assume the following
parameter values: α = 1/3, δ = 0.05, g = n = 0.02, s = 0.2. Find k˜∗ . Imagine you start
in an initial value of k̃t = 1.1. How many periods would the economy take to be
sufficiently close to its steady state k˜∗ (≈ 99% of k˜∗ )?
HINTS:

• Apply the discrete-time version of the evolution of capital

k̃t+1 − k̃t f˜(k̃t )

=s − (g + δ + n)
k̃t k̃t

• Start with k˜0 = 1.1 and apply that formula until you converge to the steady
state!