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Assignment 3

This document contains two questions regarding Ramsey growth models. Question 1 analyzes the effects of a permanent increase in government expenditure financed by lump-sum taxes. It asks how the steady state capital and consumption change, to draw the Lk and Lc loci before and after the shock, and to plot the transition path. Question 2 considers a permanent tax rate increase, financed by lump-sum transfers. It poses the same three parts about the steady state, loci, and transition path. Both questions examine how an unexpected policy change affects the long-run equilibrium and dynamic adjustment path in a Ramsey model.

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Greco S50
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39 views

Assignment 3

This document contains two questions regarding Ramsey growth models. Question 1 analyzes the effects of a permanent increase in government expenditure financed by lump-sum taxes. It asks how the steady state capital and consumption change, to draw the Lk and Lc loci before and after the shock, and to plot the transition path. Question 2 considers a permanent tax rate increase, financed by lump-sum transfers. It poses the same three parts about the steady state, loci, and transition path. Both questions examine how an unexpected policy change affects the long-run equilibrium and dynamic adjustment path in a Ramsey model.

Uploaded by

Greco S50
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Macroeconomic Theory: Assignment 3

Question 1. (50%) Consider a Ramsey growth model as we discussed in


class. Suppose that the government expenditure is gt , and the expenditure is
…nanced by charging lump sum tax from the household in each period. The
representative household solves the following optimization problem
1
X
t
maxfct ;kt+1 g1
t=0
u(ct )
t=0
8
< ct + kt+1 (1 )kt = f (kt ) gt
subject to ct ; kt+1 0 ; for t = 0 : : : 1
:
k0 = k0
Suppose that gt = 0 for t = 0; 1; : : : ; T 1, and the economy was at the steady
state. At time t = T , there is an unexpected, permanent increase in the gov-
ernment expenditure such that gt = g > 0 for all t T .
1. (15%) How do the steady state capital and consumption change as g in-
creases?
2. (15%) Draw Lk (k) and Lc (k) locus before and after the unexpected shock
on the k c diagram
3. (20%) Plot the optimal path of capital and consumption from the old
steady state to the new steady state (where the horizontal axis is time t,
and the vertical axis is capital or consumption)
Question 2. (50%) Consider a Ramsey growth model as we discussed in
class. There are mass one households. There is a government that charges a
proportional tax on outputs from each household and transfers the tax revenue
back to all households equally. The representative household solves the following
optimization problem.
1
X
t
maxfct ;kt+1 g1
t=0
u(ct )
t=0
8
< ct + kt+1 (1 )kt = (1 t )f (kt ) + dt
subject to ct ; kt+1 0 ; for t = 0 : : : 1
:
k0 = k0
Where t is the proportional tax rate, and dt is the lump sum transfer received
from the government. Let yt = f (kt ) denote the representative household’s

1
output, and let yt denote the aggregate output of the economy, then given t ,
lump sum transfer is passively determined to balance the government’s budget
constraint:
t yt = dt .

Suppose that t = 0 for t = 0; 1; : : : ; T 1, and the economy was at the steady


state. At time T , there is an unexpected, permanent increase in the tax rate
such that t = > 0 for all t T .

1. (15%) How do the steady state capital and consumption change as in-
creases?

2. (15%) Draw Lk (k) and Lc (k) locus before and after the unexpected shock
on the k c diagram
3. (20%) Plot the optimal path of capital and consumption from the old
steady state to the new steady state (where the horizontal axis is time t,
and the vertical axis is capital or consumption)

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