Macroeconomics:

Lecture 10 Slides

Maxim Nikitin
International College of Economics and Finance – NRU HSE

December 20, 2023

Maxim Nikitin Macroeconomics slides

A Model of Increasing Variety of Intermediate Inputs

N
X
Yi = AL1−α
i (xij )α
j=1
N is the number of intermediate inputs; xij is the amount of
intermediate input of type j used by firm i.
Technological progress takes the form of increasing number of
inputs.
Show that the increasing number of inputs raises the output. Let
xi
xi , the total amount of inputs, be constant. xij = N .
(xi )α
Yi = AL1−α
i N = AL1−α
i N 1−α (xi )α
Nα
Perfect competition in the production of final goods, competitive
market for inputs:
∂Yi
= AαL1−αi xijα−1 = pj
∂xij
Maxim Nikitin Macroeconomics slides
Solving for xij yields:
  1
Aα 1−α
xij = Li
pj

Increase in N requires an invention: the inventor should reap a

monopoly profit as he gets a patent for his invention. Assume that
the owner of the patent enjoys the monopoly power forever.
Let the production cost of a unit of intermediate good equal 1.
Interpretation: use the final good as a numeraire, and think of 1
unit of final good converted into intermediate good.
The discounted value of returns from discovering the intermediate
good j at time t:
Z ∞
V (t) = (pj − 1)xj e −r (ν−t) dν
t

where xj is overall usage of intermediate good j across all final

good producers, r is the discount factor, ν is the time.
Maxim Nikitin Macroeconomics slides
Optimal Price

The monopolist sets pj at each moment to maximize (pj − 1)xj ,

where
  1   1
X Aα 1−α X Aα 1−α
xj = xij = Li = L
pj pj
i i

The maximization problem:

  1
Aα 1−α
max(pj − 1)L
pj pj

A, L, α are constant.
DIY: solve the problem and verify that optimal pj = α1
pj is independent of j (and time), therefore xj is also independent
of j and time.

Maxim Nikitin Macroeconomics slides

xj = x (independent of j).

1
x = L Aαα 1−α

Substitute into V (t)

Z ∞
1
1
− 1 L Aα2 1−α e −r (ν−t) dν


V (t) =
t α
Z ∞
1
e −r (ν−t) dν =
t r
Suppose the cost of invention is η. For tractability is
non-stochastic. Assume free entry into invention business.
1−α
1 1
V (t) = L Aα2 1−α = η
α r
L1−α
1
r= Aα2 1−α
η α

Maxim Nikitin Macroeconomics slides

Household Problem and Consumption Growth Rate

Representative household maximizes the standard discounted

stream of utility:
Z ∞ 1−θ
c − 1 −ρt
U= e dt
0 1−θ
 
r −ρ 1 L1−α
1
γc = = Aα2 1−α − ρ
θ θ η α
c grows at a constant rate, no transitional dynamics
What is the asset?

Maxim Nikitin Macroeconomics slides

Asset is the Value of firms that own patents (blueprints). The
value of one such firm equals η.
α
Y = AL1−α Nx α = AL1−α NLα Aα2


1−α

Y grows at the same rate as N. The next step is to show that all 3
variables, Y , C and N grow at the same rate.
The economy’s budget constraint:

C = Y − η Ṅ − Nx

Or
α 1
AL1−α NLα Aα2 − N Aα2



1−α 1−α
1 1
Ṅ = − C = ΦN − C
η η η
where Φ is a function of exogenous constants. The last equation is
a linear first-order differential equation in N with time-varying C .
Apply TVC to show that N (and, therefore, Y ) grow at the same
rate as C .
Maxim Nikitin Macroeconomics slides
Social Planner‘s problem

∞
c 1−θ − 1 −ρt
Z
max U = e dt
0 1−θ
subject to the aggregate resource constraint:

Y = AL1−α Nx α = C + η Ṅ + Nx
can be rewritten as
1
AL1−α Nx α − Lc − Nx


Ṅ =
η
N is a state variable, c and x are control variables.

c 1−θ − 1 −ρt 1
+ µ AL1−α Nx α − Lc − Nx


J= e
1−θ η

Maxim Nikitin Macroeconomics slides

First-Order Conditions

∂J µ
= c −θ e −ρt − L = 0
∂c η
∂J µ
AL1−α Nαx α−1 − N = 0


=
∂x η
∂J µ
AL1−α x α − x = −µ̇


=
∂N η
DIY: Write down the TVC
Solve ∂J
∂x = 0 for x.
1 1
x = L(Aα) 1−α > L(Aα2 ) 1−α

Why?

Maxim Nikitin Macroeconomics slides

Monopoly power of a patent holder is a distortion (market failure)!
Monopolist produces less than socially optimal.
1
DIY: substitute x = L(Aα) 1−α in the remaining two FOCs and
compute the socially optimal growth rate of consumption:

   
1 L1−α
1 1 L1−α
1
γcSP = Aα 1−α
−ρ > Aα 2 1−α
−ρ = γcCE
θ η α θ η α

What is the reason?

Maxim Nikitin Macroeconomics slides

Distortions

Two kinds of distortion in the model:

Static distortion - underproduction of monopolistically
produced intermediate goods.
Dynamic distortion: underproduction of intermediate goods
reduces the market clearing interest rate and growth rate of
the economy, γc = γN = γY

Is it possible to achieve the first-best allocation in this economy?

Maxim Nikitin Macroeconomics slides

Potential Ways to achieve the First-Best

Subsidy to purchases of intermediate goods. It addresses

both, the static and dynamic distortion. If the subsidy is at
the rate (1 − α), the producer of Y pays only αP = 1 for
each unit of x. The equilibrium quantity of intermediate
goods coincides with the social planner’s choice.
Subsidy to final product. It increases the demand for
intermediate inputs and addresses both, the static and
dynamic distortion.
Subsidy to research. The planner can partly subsidize the cost
of invention to ensure that market clearing r coincides with
the socially optimal one. The growth rate equals the first-best
one, but the static distortion is not addressed.

Maxim Nikitin Macroeconomics slides