ECA5102 Macroeconomics

Huang Kui, Angela

Assignment 2
Due on 11 October, Friday at 5 pm.
Please submit your assignment to my mailbox on the 6th floor before the deadline. Write
your name, registration number, and lecture group (e.g., Group 1 on Monday).

1. (Williamson Ch9 Q5) A consumer receives income y in the current period, income y0
in the future period, and pays taxes of t and t0 in the current and future periods,
respectively. The consumer can borrow and lend at the real interest rate r. This
consumer faces a constraint on how much he or she can borrow, much like the credit
limit typically placed on a credit card account. That is, the consumer cannot borrow
more than x, i.e., c ≤ y − t + x, where x < we − y + t, with we denoting lifetime wealth.
Use diagrams to determine the effects on the consumer’s current consumption, future
consumption, and savings of an increase in x, and explain your results.
(Hint: Discuss cases when the consumer originally chooses the interior solution or the
corner solution respectively. )
2. This problem considers a variation on the Solow model. Suppose that instead of the
population growing at a constant rate, that people have fewer children as they become
wealthier. In particular, as always suppose that output is produced via a Cobb-Douglas
production function Y = K α L1−α , where technology is A = 1 and thus its growth rate
is g = 0 for simplicity. Consumers save a constant fraction s of their income, and the
capital stock depreciates at rate δ. The capital stock evolves according to the following
equation
dK
≡ K̇ = sY − δK
dt
Define the per-capita variables as k = K/L, y = Y /L, and c = C/L. However, instead
of being a constant, now the population growth rate is proportional to the marginal
product of capital (M P K):
L̇
= n · MP K
L
where n > 0. Since the M P K falls as capital increases, this captures the declining
population growth rates of wealthier nations.
dk d(K/L)
(a) Derive the equation of motion for per-capita quantities of capital k̇ ≡ dt
= dt
.
(b) Determine the steady state per-capita quantities of capital, output, consumption,
and population growth.
(c) What are the short run (transitional dynamics) and long run (steady state) effects
of an increase in n on the per-capita quantities of capital, output, consumption,
and the population growth rate?

1
 (Hint: Notice that

Y L̇
y= = kα = n · MPK = nαK α−1 L1−α = nαk α−1
L L
K̇L−L̇K K̇ K L̇
Then k̇ = L2
= L
− L L
)
3. In 1861 many southern US states seceded and formed the Confederacy. Treat the North
and South as two separate countries, and analyze the effects of the secession and the
Civil War using the Solow model. Suppose that the rate of population growth n is the
same in the North and South, but the North had a higher rate of productivity growth
g, a higher savings rate s and a higher productivity level A.
(a) What does the model predict about the long run (Balanced Growth Path) compar-
ative economic performance (both growth rates and levels of per capita output)
of the North and South?
(b) During the Civil War, much of the capital stock in the South was destroyed, and
after the war the country was reunited. Suppose that after war the whole US had
the same (high) TFP growth rate g, savings rates s and TFP level A, that were
predominant in the North. What does the model predict about the comparative
economic performance (both growth rates and levels of per capita output) of
the North and South after re-unification? Consider both the long run (Balanced
Growth Path) and short run (transitional dynamics).
(Hint: This is a half-open question. You can assume the North was on its balanced
growth path, so that capital per unit of effective labor k̃ = K/(AL) was constant
before re-unification, to simplify the discussions. )