ECON 20210 - Problem Set 5 Solutions

2 Exercises
2.1 Investment costs
(a)
i
Ĥ = f (k) − i(1 + φ( )) + q(i − δk)
k
The relevant first order conditions are:
i i i
Ĥi = −1 − φ( ) − φ0 ( ) + q = 0,
k k k
i i
q̇ = qr − Ĥk = qr − f 0 (k) − ( )2 φ( ) + δq,
k k
k̇ = i − δk.

(b)
Ĥi = −1 − φ(x) − xφ0 (x) + q = 0
Then differentiate
Ĥi = −1 − φ(γ(q)) − xφ0 (γ(q)) + q = 0
w.r.t. q to obtain the desired equation for γ 0 (q).

(c)
i i
q̇ = qr − Ĥk = qr − f 0 (k) − ( )2 φ( ) + δq
k k
⇒ q̇ = q(r + δ) − (γ(q)) φ (γ(q)) − f 0 (k)
2 0

k̇ = i − δk
⇒ k̇ = k(γ(q) − δ)

(d) Substitute
xφ0 (x) = −1 − φ(x)
into
⇒ q̇ = q(r + δ) − x(xφ0 (x)) − f 0 (k).

If you differentiate the expression for q(t) w.r.t t using the Leibniz rule, you will get
the expression for q̇(t). The value of a unit of capital, q, is the discounted value of its
marginal marginal productivities plus adjustment cost savings.

(e)
η(k)(r + δ) − [γ(η(k))]2 φ0 (γ(η(k))) = f 0 (k)

(f) Use the hint.

1
(g)
q ∗ = 1 + φ(δ) + δφ(δ) = 1
Then use the first order conditions.
(h)
f 00 (k ∗ ) f 00 (k ∗ )
η 0 (k ∗ ) = =
r+δ−δ r
(i) Qualitatively, the graph looks the same as the one from the lecture notes.

(j) Evaluate
∂ q̇
= r + δ − 2γ(q)γ 0 (q)φ0 (γ(q)) − [γ(q)]2 φ0 (γ(q))γ 0 (q),
∂q
∂ q̇
= −f 00 (k)
∂k
∂ k̇
= kγ 0 (q)
∂q
∂ k̇
= γ(q)
∂k
at the steady state and plug them in the formula for 1st order Taylor approximation.
−f 00 (k ∗ )
 
r
k∗
2φ0 (δ)+δφ00 (δ)
0
Set det(A − λI) = 0.

2
(k)
dk̇ 0 2 dk̇ dq̇ dq̇
( )(s ) + ( − )s0 − =0
dq k q k
k∗
( )(s0 )2 + (−r)s0 + f 00 (k ∗ ) = 0
2φ0 (δ) + δφ00 (δ)
q
k∗ 00 ∗
r− r2 − 4( 2φ0 (δ)+δφ00 (δ) )f (k )
s0 = k∗
2( 2φ0 (δ)+δφ00 (δ) )

Ramsey-Cass-Koopmans
(a)
γk,t = 0 ⇔ ct ∼ f (kt ) − (δ + g + n)kt
The curve goes up. (Higher c, given the same k.)

(b)
γc,t = 0 ⇔ 1 + g = [β(1 + f 0 (kt ) − δ)]1/θ
The curve moves to the right. (k ∗ is higher.)

(c) Consumption goes up.

[β(1 + f 0 (kt ) − δ)]1/θ − (1 + g)

γc,t =
1+g
is decreasing w.r.t. g, given kt .

3
(d)
γc,t = 0 ⇔ (1 + g)θ = β(1 + f 0 (k ∗ (g)) − δ)
Totally differentiating each side w.r.t. g,

dk ∗ dk ∗ θ(1 + g)θ−1
θ(1 + g)θ−1 = βf 00 (k ∗ ) ⇒ =
dg dg βf 00 (k ∗ )

Total savings per efficiency unit is

(δ + g + n)k ∗

. So, the savings rate is

(δ + g + n)k ∗ (g)
s(k ∗ (g)) = .
f (k ∗ (g))
So, the impact of a marginal change in g on the fraction of output that is saved on the
BGP is
ds(k ∗ (g)) (δ + g + n)f (k ∗ (g)) − (δ + g + n)k ∗ (g)f 0 (k ∗ ) dk ∗
=
dg f (k ∗ (g))2 dg
(δ + g + n)(f (k ∗ (g)) − k ∗ (g)f 0 (k ∗ )) dk ∗
=
f (k ∗ (g))2 dg
ds(k∗ (g))
f 00 (k) < 0 implies f (k) − kf 0 (k)) > 0. So, dg
is negative.

(e)
ds(k ∗ (g)) (δ + g + n)(f (k ∗ (g)) − k ∗ (g)f 0 (k ∗ )) θ(1 + g)θ−1
=
dg f (k ∗ (g))2 βf 00 (k ∗ )
(1+g)θ
Plugging in f (k) = k α , f 0 (k ∗ ) = δ + β
− 1,

(1+g)θ
ds(k ∗ (g)) (δ + g + n)((k ∗ )α − k ∗ (δ + β
− 1)) θ(1 + g)θ−1
=
dg (k ∗ )2α βα(α − 1)(k ∗ )α−2
(1 + g)θ θ(1 + g)θ−1
= (δ + g + n)((k ∗ )−2α+2 − (δ + − 1)(k ∗ )−3α+3 )
β βα(α − 1)
αβ 2 (1 + g)θ αβ 3 θ(1 + g)
θ−1
= (δ+g+n)(( ) −(δ+ −1)( ) )
(1 + g)θ − β(1 − δ) β (1 + g)θ − β(1 − δ) βα(α − 1)