Name: __ce wang________________________ Date: __3/25/2013___________

1. Explain the following concepts:

Investment, Depreciation, Marginal product of capital, Steady state, Golden rule level of
capital, Break-even investment

cInvestment is expenditure on new plant and equipment, and it cause the capital stock to rise.
Depreciation is the wearing out of old capital, and it causes the capital stock to fall. Marginal
product of capital is the additional output resulting from the use of an additional unit of capital.
Steady state: if economy finds itself at this level of the capital stock, the capital stock will not
change because the two forces acting on it-investment and depreciation k*, k=0, so the capital
stock k and output f(k) are steady over time. We therefore call k* the steady-state level of capial.
Golden rule level of capital:the steady-state value of k that maximize consumption is called the
Golden rule level of capital. Break-even investment: A break-even point defines when an
investment will generate a positive return and can be determined graphically or with simple
mathematics.

2. Problem 1 on page 219.

a.The production function has a constant returns to scaleif increasing all factors of production
byan equal percentage causes output to increase by the same percentage.

A production function has constant returns to scaleif zY = F(zK, zL) for any positive number
z.That is, if we multiply both the amount of capital and labor by some positive amount z, then
the amount of output is multiplied by z. For example, if we double the amounts of capital and
labor we use (setting z=2), then output also doubles.o see if the production functionY = F(K,L) =
K1/2L1/2has the constant returns to scale, we multiply K and L by a factor of z:

F(zK,zL)=(zK)1/2(zL)1/2=z1/2+1/2 K1/2L1/2=zK1/2L1/2=zY.

Therefore,zY = F(zK, zL).The production functionY = F(K,L) = K1/2L1/2has the constantreturns

to scale.

B. Y/L=K1/2L1/2 /L= K1/2L1/2 /L1/2+1/2 = K1/2/L1/2 =(K/L)1/2=k1/2

Then, y=k1/2 =f(k)

C. δ= depreciation rate = 0.05,

sa= savings rate ofcountry A = 0.1,

sb= savings rate of country B = 0.2,

i=δ, sf(k)=δk, sk1/2=δk k1/2 =δ/s *(k) k=(s/δ)2

A:K*=(0.1/0.05)2=4. B: K*=(0.2/0.05)2=16

Page 1
A: y=k1/2=41/2=2. B: y= 161/2=4

A: C=(1-s)y=(1-0.1)*2=1/8 B: C=(1-s)y=(1-0.2)*4=3.2

D.sa= 0.1 sb= 0.2δ= 0.05for both countries,

initial capital stock k = 2 for both countries,

Y=k1/2for both countries,c=(1-s)yfor both countries.

CountryA

Country B

the

initial consumption was higher in country A than in country B, because savings rate incountry B is
higher.We can see that,it takes five yearsfor country B to haveconsumptionshigher thanthe consumption
in country A.

3. Problem 3 on page 219 (hint MPK = 0.3k-0.7)

A. Y=F(K,L)=K0.3L0.7

Y/L= K0.3L0.7/ L= K0.3L0.7/L0.3+0.7 =K0.3L0.7/ L0.3L0.7 =K0.3/L0.7=(K/L)0.3=K0.3

B.
K*/f(k*)=s/δ. K*/K*0.3=s/δ, K*0.7= s/δ. K*= (s/δ)1/0.7

K*0.3=(s/δ)0.3/0.7. C*= (s/δ)0.3/0.7- δ(s/δ)1/0.7

C.

Page 2
 4. Problem 6 on page 220

Steady
State
Level-
given a
decrease
in N: per-
worker
capital:
increased.
Per=worker production:increased. Per-worker consumption: increased.
5. Explain graphically how to find the golden rule capital and saving rate with and without
population growth. Be sure to label the axes and the curves.
δk*
steady state
output and
depreciation

Sgold f(k*)

f(k*)

steady-state
capital per
worker, k*

This is only one saving rate that produces the Golden Rule level of capital k*gold. Any change in
the saving rate would shift the sf(k) cure and would move the economy to a steady state with a
lower level of consumption.

6. Draw the Solow model diagram, labeling the steady state k*. On the horizontal axis, pick
a value greater than k* for the economy’s initial capital stock. Label it k1. Show
graphically what happens to k over time. Does k move toward the steady state or away
from it?

Investment,
break-even
investment
( δ+ n ) k

Page 3
 sf(k)

Capital per worker, K

K*

An increase in n causes an increase in break-even investment,leading to a lower steady-state

level of k.
7. Suppose that two countries are exactly alike in every respect except that the citizens of
country A have a higher saving rate than the citizens of country B.

Page 4
Page 5
Page 6
 9. The initial steady-state level of capital per worker in Macroland is 5. The Golden Rule
level of capital per worker in Macroland is 8.
a. What must change in Macroland to achieve the Golden Rule steady state?
It must increase its savings rate. This will increase the level of per person
capital in the economy.

b. Why might the Golden Rule steady state be preferred to the initial steady
state?

The Golden Rule is where long-term consumption is maximized, while current

consumption is definitely less than this. If Macroland cares about the welfare of
its future citizens, achieving the Golden Rule level is a good objective.

c. Why might some current workers in Macroland prefer the initial steady state
to the Golden Rule steady state?
Increasing the savings rate means that per person consumption will initially go
down, while the gains in consumption will occur only later. Thus, if a country
heavily discounts the future (in other words, if it puts a high value of present
consumption relative to future consumption), this change might be too
“painful,” and it would be better off not going to the Golden Rule.

10. Assume  = 0.2, y = k 1/2, and MPK = 0.5/ k 1/2

Find the Golden Rule capital stock and the corresponding saving rate.
0.2=0.5/k1/2 , k=0.5 0.5/0.51/2 =s/0.2 s=0.4

Page 7