MACROECONOMICS-III: ECO-313

Session: Spring 2015

Instructor: Dr. Adnan Haider
Assignment No. 1
Submission Date: Attach Solution with Term Exam I
(1)

In a few words explain/describe the following:i. Neo-Classical Production Function? Give three specific examples of
such a function.
ii. Intensive form of the production function? Why is at helpful in
analysis?
iii. Concept of Steady State? In what sense this is an equilibrium state?
iv. Variables of simple Solow Model of economic growth? What are the
constants/parameters of the model?
v. Behavior of variables of Solow Model in the steady state?
vi. Transitional dynamics? Why we may call such analysis as short-term
analysis?
vii. Golden Rule of capital accumulation. How is it achieved? What is the
relationship between steady state and Golden Rule of capital
accumulation?

(2)

Consider a Cobb-Douglas production function Y (t ) A.K (t )0.5 .L(t )0.5 , where, Y is

total output, K is capital stock, L is labor, A is the index of technological progress
and is fixed. Suppose further that 20% of income is saved each year:
i. What is the intensive form of the above function?
ii. Suppose A=1 and there is no labor growth. Furthermore, capital
depreciates at the rate of 5%. Find the steady state values k*, y* and c*
(i.e. per capita capital, income and consumption).
iii. Use the steady state condition to derive a relationship between s and
k*. Find out k*, y* and c* for saving rates of 10%, 20%, 30%, 40%,
50% and 60%. What saving rate gives the golden rate of capital
accumulation, income and consumption?
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iv. Answer (ii) and (iii) when the depreciation rate is 10%?
v. Now assume that in the production function exponent of capital
(capital share) is 0.3 and labor share is 0.7. Answer (ii), (iii) and (iv)
under this assumption. What are the lessons we get with this change?
Explain your results. (Note: You will find it more useful to create an Excel
Workbook and carry out the calculations.)

(3)

Consider two economies, both having the production function y(t ) k (t )0.5 .
[Note that the production function is in intensive form]. The rate of capital
depreciation is 5% and there is no population growth. Assume further that
country A saves 10% while country B saves 20% of their respective incomes.
i. What are the steady state values of k*, y* and c* for the two
economies?
ii. If both economies start with an initial k(0)=2, would both of them
converge to the same steady state or their respective steady states?
What kind of convergence is witnessed in this case?
iii. Suppose the economy A experiences a positive population growth rate
of 2%. Answer (i) and interpret you results.
iv. Assume there is no population growth in country A. At what growth
rate of population in country B, its advantage of better savings rate
will be neutralized?
v. The closed form solution of the fundamental equation of Solow Model
for a Cobb-Douglas production function is given by:

k
*

1 a

sA
sA
k (0)1a
exp (1 a)(n )t
n
n

where a is the share of capital, s is the saving rate A is the

constant in Cobb-Douglas production function (which in the present
problem was assumed to equal 1), d is the depreciation rate, K(0) is
the initial value of capital, exp is the exponential function and t is
time. (Recall that the solution of a differential equation requires
expression of a variable only as a function of time, which is what is
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given in the above equation, where the time path of steady state value of
k* is expressed).
Answer the following:
a) Use the data of country A and B to calculate the rates of growth (g)
at which their respective initial values of k(0) approach k*?
b) A half-line is defined as the time taken by a variable to approach
its target value and is given by t*=loge(2)/g, where g is the growth
rate. Find out the t* for country A and B.
c) A further adjustment of remaining half line will take place if we
follow the same procedure as in (part b), thus covering 3/4th of the
distance. Continue this process until at least 90% distance is
covered. In how many years, at least 90% adjustment will take
place?
(4)

Derive the following expression for changes in growth rate of per capita
income as per capita capital changes?

y / y
k

f (k ).k . k

(n ) f (k )
f (k ) k
. 1 sh(k )
f (k )

Where: sh(k) =: share of capital, n=: population growth rate, := depreciation rate.

(5)

Derive an expression for calculating the effect of a change in per capita

income due to a change in saving rate (i.e, dy/ds) also verify that:

K (k * )
s y*

y* s 1 K (k * )
k * . f (k * )
Where:
is the elasticity of output with respect to capital at k=k*
f (k * )

--Good Luck--