ECON 302: Intermediate Macroeconomic Theory (Spring 2012-13)

Discussion Section Week 4 – February 15, 2013

SOME KEY CONCEPTS

- Continuation of Solow Growth Model: Steady State, Dynamics of Capital and Output
- Introduction to Romer Model

EXERCISE
Question 1 (Graph of Solow Growth Model – Adapted from Midterm 2, Fall 2006)
On the graph of the Solow growth model, where d represents the depreciation rate and s is the investment
rate, show the effects of an increase in the investment rate.
(a) Label each axis on the graph. Draw and label the curves.
(b) Let the economy be initially in a steady state. Label that point 1 and show as initial value of capital,
K1 .
(c) Show the shift in the curve that occurs when the investement rate increases.
(d) Use arrows to show how capital evolves over time after investment rate increases.
(e) How have output and consumption changed from the initial steady state to the new steady state?

Question 2 (Movement Along or Shift of the Curves?)

Distinguish the following scenario towards the diagram of the Solow growth model. What curve(s) are shifted?
(Hint: Think about the underlying equations in the diagram of Solow growth model.)
(a) Permanent increase in investment rates
(b) Permanent decrease in depreciation rates
(c) Permanent increase in total factor productivity
(d) One-time increase in capital stock (think of some amount of capital dropping from the sky once)
(e) One-time increase in labor force

Question 3 (The Dynamics of Capital and Output)

Let us remind the example of immigration. We wish to analyze the effects towards the long run level of
capital and output. Suppose the economy is initially in a steady state. The immigration policy creates a
one-time increase in labor supply. (You can think that 1,000 people walk into the country and that’s all!)
(a) What is the effect towards the steady state level of capital after the immigration policy?
(b) Draw the graph of Solow growth model. Denote the fact that the economy is initially in a steady state.
(c) Show the shift in the curve that occurs after immigration policy.
(d) Write the arrows to show the evolution of capital after immigration policy.
(e) Draw the graph showing the capital and output over time, clearly show before and after the policy.

Suppose instead that there is an event that capital is wiped out by half from the economy, repeat the same
questions.

Question 4 (Introduction to Romer Model)

Suppose the economy has fixed L amount of labor supply, of which ` fraction works in idea production and
1 ` works in output production. So that Lat = ` · L and Lyt = 1 ` · L. Let the idea production function
be At+1 = zAt Lat , i.e. At+1 = (1 + zLat ) At . The output production is Yt = At Lyt . What is the growth
rate in output per capita, namely, what is gyt = yt+1yt yt ?