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Homework 1 Macro

The document discusses the analysis of the CES utility function and its properties through numerical exercises, including calculations and graphing for various parameter values. It also explores constrained utility maximization for a household and examines the business cycle in Spain, focusing on GDP deviations, volatility, and correlations among economic indicators. The document highlights significant historical events affecting Spain's economy, particularly the oil crisis of the 1970s and its impact on investment and consumption.

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8 views5 pages

Homework 1 Macro

The document discusses the analysis of the CES utility function and its properties through numerical exercises, including calculations and graphing for various parameter values. It also explores constrained utility maximization for a household and examines the business cycle in Spain, focusing on GDP deviations, volatility, and correlations among economic indicators. The document highlights significant historical events affecting Spain's economy, particularly the oil crisis of the 1970s and its impact on investment and consumption.

Uploaded by

irachedelavega
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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1.

Numerical exercise: the CES utility function


A class of utility functions that is very important is the class of constant
elasticity-of-substitution (CES) or power utility functions

In this exercise we study the properties of this function numerically. Use a spreadsheet
program such as OpenOffice or Excel or another maths/statistics program to answer the
following questions.
1. In a table, calculate the utility from consuming the quantities c = 0.1, 0.2, . . . 2.9, 3.0
for each of the parameter values γ = 0, 0.3, 0.7, 1, 2, 4, 10.

2. With the computer, graph the function u for each of the values γ = 0, 0.3, 1, 2.
3. Briefly comment (about 3-5 sentences) on the properties of the function and how they
depend on γ
The function becomes more and more concave as Y increases. We should also look at how,
no matter the value of Y at c=1 the value of all utilities converges to 1.

2 Constrained utility maximization


Consider a household facing the following utility-maximization problem:

where c and l denote, respectively, the level of consumption and the amount of time spent
working and 0 < ϕ < 1 is a constant. Also, I = l1/2 represents an elementary production
function for this household.
By using both the substitution and the Lagrangian method of optimization, calculate the
consumption and labor supply.

3. The business cycle in Spain


3.1 Trend and deviations
Calculate the deviations ˜yt , ˜ct , ˜it and ˜gt of yt=ln Yt (Y : gross domestic product, GDP),
ct=ln Ct (C: domestic private consumption), it=ln It (I: gross fixed capital formation) and
gt=lnGt (G: public consumption) from their respective trends τt (for example: ˜yt = yt − τ (y)
t).
1. Make a graph of the log gross domestic product yt and its trend τt against time, and
another of the deviations of the trend ˜yt against time. Identify at least two exceptional
periods in the (economic) history of Spain.

In the second graph we can see several events that made GDP drop. If we had to highlight
some, it is important to look at the oil crisis that produced a negative shock to GDP in 1974,
as well as the financial crisis in 2008.

2. What is the economic interpretation of the deviations ˜yt etc. that you have just
calculated?
The typical deviation of GDP from the trend is of 1,24%, of consumption it is 1,27%, of
government expenditure it is 1,28%, and form investment it is 4,52%.

3. Make a graph of the series ˜yt , ˜ct , ˜it and ˜gt against time. Comment.
As we can also see, by calculating the standard deviation, the more volatile element in the
economy is investment, which has higher highs and lower lows. The rest of the elements;
consumption and government expenditure, follow a similar pattern as the GDP deviation
from the trend.

3.2 Volatility and covariation


1. Calculate the standard deviations of: ˜yt , ˜ct , ˜it and ˜gt .
(a) What is the interpretation of these standard deviations you have just calculated?
The typical deviation of GDP from the trend is of 1,24%, of consumption it is 1,27%, of
government expenditure it is 1,28%, and form investment it is 4,52%.
(b) Are they similar to the patterns in volatilities in the U.S. (that we saw in class)? Comment.
Yes, once again we see that investment is the most volatile element

2. Calculate the coefficients of correlation of ˜ct , ˜it and ˜gt with ˜yt .

(a) What is the interpretation of the correlations you have just calculated?
(b) Are they similar to the patterns of correlation in the U.S. (that we saw in class)?
Comment.

3.3 Free choice


Focus on whichever pattern or peculiarity in the data you consider interesting (for example:
changes in volatility over time, extreme events,. . . ).
1. Describe the pattern/peculiarity in words and justify your argument with some
statistics obtained from the data.
I am going to focus on the oil crisis in the 70’s. We can see a high peak in 1974 and then a
strong decline, in the graph comparing the trend of growth with the deviation from the GDP.
It is also shown in the graph where all deviations from the trend are shown. Once again there
is especially a peak in investment in 1974, followed again by a strong decrease.

2. Try and find economic/political/historical reasons for what we are seeing in the
pattern/peculiarity that you are describing.
In response to the west’s support to the israeli conflict, arab countries decided to raise prices
in 1973, which significantly affected the global economy. Spain was not an exception. Prices
rose because of the expensive prime resources, creating an important inflation. Spain was
also affected by Franco’s strict economic policies, which made it harder for the economy to
adapt, as well as the decline in tourism because of the crisis. Spain was highly dependent on
tourism at the time, so when it decreased a big sector of the economy suffered.

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