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Homework1 Africa

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bertha82
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4 views2 pages

Homework1 Africa

Uploaded by

bertha82
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Homework I (Suggested)

1. Shocks to income and the interest rate


Consider the problem of a household that maximizes:
∞
X
max β t log ct
ct
t=0
s.t. ct + st = yt , ∀ t > 0
bt+1 = (1 + rt )bt + st
yt = ȳ + ρyt−1 + σε εt
rt = r̄ + ση ηt
b0 given

where ȳ is the average income, εt ∼ N (0, 1), and ηt ∼ N (0, 1).

1. What are the states and controls of this dynamic optimization problem?

2. Can you write the associated Bellman equation?

3. What role do you think ρ plays in the law of motion for yt ? Can you think of a good
economic interpretation?

2. Habit persistence
Consider the same problem as before, but know the household displays “habit persistence”:
i.e., you get utility from living better than yesterday (evolutionary biologists think there are
good reasons why our brains are wired in that way):

(ct − 0.8ct−1 )1−γ


u(ct , ct−1 ) =
1−γ
where γ > 1.

1. What are now the states and controls of this dynamic optimization problem?

2. Can you write the associated Bellman equation?

1
3. Endogenous labor
Consider the same problem as in exercise I, but now, the household chooses how much to
work given a wage wt per unit of time, lt worked:
∞
X
max β t log ct − lt
ct
t=0
s.t. ct + st = wt ∗ lt , ∀ t > 0
bt+1 = (1 + rt )bt + st
wt = w̄ + ρwt−1 + σε εt
rt = r̄ + ση ηt
b0 given

(we assume that the household can work as much as it wants, e.g., it works on a family farm).

1. What are now the states and controls of this dynamic optimization problem?

2. Can you write the associated Bellman equation?

4. An investment problem
A firm invests it on physical capital kt given some depreciation rate δ:

kt+1 = (1 − δ)kt + it .

Capital is used to produce a good, yt = ktα , where α < 1, sold at price pt :

pt = p̄ + ρpt−1 + σεt

where εt ∼ N (0, 1).


The firm discounts the future with the discount rate β and values its cash flow, pt yt − it ,
linearly.

1. Can you write the whole optimization problem of the firm?

2. Why do you think it makes sense to assume that the firm values its cash flow linearly?
Why do you think we do not need concavity, as in the utility function of the household?

3. What are now the states and controls of this dynamic optimization problem?

4. Can you write the associated Bellman equation?

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