MACREC2:

Intermediate Macroeconomics 2 V24/V25/V26 MW/TH 0940-1110/1120-1250/1120-1250 Y604/Y402/L210 Problem Set 1: The Facts of Growth Professor: John Paolo R. Rivera, Ph.D. 1. Replicate the Solow Growth Model using a Hicks-Neutral production function. Instead of focusing on capital per effective labor, focus on labor per effective capital. What are the major similarities and differences? 2. Consider Azerbaijans production function Y = K0.5L0.5. a. Compute aggregate output when K = 50 and L = 90. b. If both capital and labor double, what happens to output? Show mathematically. c. If both capital and labor triple, what happens to output? Show mathematically. d. Show that the production function satisfies constant returns to scale. e. Show that the production function satisfies Inada conditions. f. Express the production function in its intensive form. Explain the role of the technological shifter. g. Let capital per effective worker equal to 8. What is output per effective worker? Now, double capital per effective worker to 16. Does output per effective worker more or less than double? Explain what is happening here. h. Does the relation between output per worker and capital per worker exhibit constant returns to scale? Show mathematically i. If your answer in (h) the same with (d)? Explain. j. Plot the relation between output per effective worker and capital per worker. Does it satisfy the assumptions of Solow about the aggregate production function? 3. Consider Azerbaijans production function in (2). Assume that N is constant and equal to 1. a. Derive the relation between the growth rate of output and the growth rate of capital. b. Suppose we want to achieve output growth equal to 2 percent a year. What is the required rate of growth of output? c. In (b), what happens to the ratio of capital to output over time? d. Is it possible to sustain output growth at 2 percent forever in Azerbaijan? Why or why not? 4. Suppose that Icelands aggregate production function is given by Y = K0.4(AL)0.6 and that the saving rate, s, is 16 percent and that the rate of depreciation, , is equal to 10 percent. Further suppose that the number of workers grows at 2 percent per year and that the rate of technological growth is 4 percent per year. a. Find the steady state values of: i. Capital stock per effective worker ii. Output per effective worker iii. Consumption per effective worker iv. Growth rate of output per effective worker v. Growth rate of output per worker vi. Growth rate of output vii. Golden rule capital per effective worker b. Suppose that the rate of technological progress doubles to 8 percent per year. Re-compute your answers in (a). c. Now, suppose that the rate of technological progress is still equal to 4 percent, but the number of workers now grows at 6 percent per year. Re-compute the answers to (a). Are people in Iceland better off in (a), (b), or (c)? 5. Suppose the Vietnamese economy is characterized by the production given by Y = K0.5(AL)0.5. a. Characterize . Let = 0.5 b. Derive the steady state levels of output per effective worker and output per effective worker in terms of the saving rate, s, and the depreciation rate, .

c. Derive the equation for steady state output per worker and steady state consumption per worker in terms of s and . d. Suppose that = 5 percent. Compute the steady state output per effective worker and steady state consumption per effective worker for s = 0, 0.1, 0.2, , 1. e. Graph your results. 6. Let us introduce government spending in the basic Solow model. Consider the basic model without technological change and the domestic absorption be Y(t) = C(t) + I(t) + G(t), with G(t) denoting government spending at time t. Suppose also that G(t) = Y(t). a. Discuss how the relationship between income and consumption should be changed. Is it reasonable to assume that C(t) = sY(t)? Explain intuitively and mathematically. b. What is the effect of higher government spending on the equilibrium of the Solow model?