Introduction to Modern Macroeconomics I

Problem Set 7
Hosein Joshaghani, Mahdi Mir
Due May 31, 2021

1 RBC: Households Own the Capital Stock

Now we consider a version of the decentralized problem in which the households own the
capital stock and rent it to firms. Otherwise the structure of the problem is the same. In this
problem set we want to show that this method ends up to similar results.

1.1 Household Problem

The household consumes and supplies labor. Now it also owns the capital stock. It earns a
rental rate for renting out the capital stock to
firms each period, Rt .
1. Write down the budget constraint for this problem.
2. Write down the HH problem.
3. Form the Lagrangian.
4. Write down the FOCs.
5. Form the Euler equation and the labor supply optimality condition and compare them
with similar equations in the model that firms own the capital not the households.

1.2 The Firm Problem

The firm problem is similar to before, but now it doesn’t choose investment. Rather, it
chooses capital today given the rental rate, Rt . Note that the
firm can vary capital today even though the household cannot given that capital is prede-
termined. The labor choice and debt choice are similar.
1. Write down the firm’s problem.
2. Form the Lagrangian.
3. Write down the FOCs.
4. Interpret the FOCs.

1.3 Equivalence to the Other Setup

Show that the two setup are identical. You need to show that all the
first order conditions are the same.

1
2 Quantitative Analysis of the RBC
For the RBC model that we have introduced in class and thoroughtly investigated in this
and the previous problem set, Here are the parameters of the model:

Θ = (α, β, δ, θ, ρA )

2.1 Steady State Analysis

1. Calibrate the model and justify your paramterization.

2. Use your results from the previous problem set to find the equilibrium (steady state)
levels of (K, N, I, Y, C, w, R, r) for the above calibration.

3. Comparative Statics: Now fix all the above parameters, except α. Change α from 0 to
1 and solve for the steady state level of K, N, I, Y, C, w, R, r. For each of these 7 state,
endogenous control and price variables depict a graph with α on the horizontal axis and
the variable of interest on the vertical axis. Interpret your results.

4. Now repeat the above excercise for each of the above paramters (β, δ, θ, ρA ) and interpret
your results.

2.1.1 The Frisch Elasticity of Labor Supply

In class we introduced the Frisch elasticity of labor supply with the interpretation of the
percentage change in employment for a percentage change in the real wage, holding the marginal
utility of wealth (i.e. the Lagrange multiplier from the household’s problem)
fixed, which with these preferences is like holding consumption fixed.

1. Write down the log linearized version of the labor supply equation and show that the
slope of this line in the (w, N ) space is 1/γ where

N∗
γ=
1 − N∗

2. Use the equations of the previous problem set to show that

1−α
γ= αβδ
θ(1 − 1−β(1−δ) )

3. Comparative Statics: For each of the parameters Θ = (α, β, δ, θ) depict a graph with γ
on the vertical axis and the parameter of interest on the horizontal axis.

4. Interpret the above comparative statics.

2.2 Dynamics of the Model

Here we want to write a Dynare program that simulates the path of the economy in response
to a productivity shock. Calibrate ρH L
A = 0.995 and ρA = 0.8. For each of these paramateriza-
tions, depict the path of the economy to the steady state and compare the results.