Narne and immatriculation number:

Exam, Advanced Macroeconomics 1, Part 1, WS 12/13

Prof. Fuchs-Schiindeln, Ph.D.

Time allowed: 60 minutes

The exam has 5 questions and you can reach 60 points in total. At the beginning of each
question the total number of achievable points is stated. Similarly, for each subquestion
the number of achievable points is stated. You should use the points as a guideline for how
much time to spend on each question.

Please write your name and immatriculation number on the top of each sheet of the
examination book and the handout with the questions. Write all your answers in the
examination book. The handout with the questions has nevertheless to be returned.

Good luck!

Question 1 ( 4 points)
A representative agent maximizes lifetime utility

where Ct represents consumption anq f3 the discount rate. He owns initial assets A 0 and receives a
stochastic income yt in each period. ·The government levies a lump sum tax Tt that might vary over
time s.t. the per period budget constraint is given by

At+ I
Ct +- - + Tt = yt +At.
1+r

Is the tax distortionary? Explain your answer intuitively. (You do not need to calculate anything).
Question 2 (9 points)
A consumer maximizes

subject to
At+i+I = (1 + r)[At+i + yt+i - Ct+il
where Ct represents consumption and f3 the discount rate. He can save and borrow at the risk-free
rate r and receives a stochastic income yt in each period. Assume further ,8(1 + r) = 1.
(a) (5 points) Solve the optimization problem and show that this implies the following Euler equa-
tion in period t:

(b) (2 points) What does this Euler equation imply for the expected time path of consumption
and for expected consumption growth Et[.6.Ct+IJ? (Just state your answer, no explanation is
necessary).
(c) (2 points) What property of the quadratic utility function leads to this particular expected time
path of consumption?
Question 3 (13 points)
A mine operator must decide how much ore to extract from a mine that will be shut down after T
years of operation. The price of extracted ore is p dollars per ton and the total cost of extracting x
tons of ore in any year, given that the mine contains St tons at the beginning of the year, is c(st, Xt)
dollars. The mine currenLly contains s tons of ore. The per-period profit of Lhe firm is given by
7ft = PXt- c(st Xt) and the amount of ore in the mine evolves according to the equation St+l = St- Xt .
(amount of new ore is equal to the old amount minus the extracted amount). Furthermore profits
iri future periods are discounted by a discount factor 8.
(a) (1 point) Is Lhis a finite or an infinite horizon problem?
(b) (1 point) Is this a stochastic or a deterministic problem?
(c) (1.5 points) What is (are) the state variable(s)?
(d) (1.5 points) What is (are) the control variable(s)?
(e) (4 points) State the Bellman equation for this problem.
(f) (4 points) How would you proceed to solve such a problem? Do not calculate anything, but just
explain in your own words.

Question 4 (15 points)

Consider the following overlapping generations model. Each cohort lives forT periods, works in the
first R periods of life and is rewarded with income Yin each working period, retires in period R + 1
and lives until the final period T from the savings accumulated throughout the working life. Assume
{3 = 1, r = 0, i.e. agents desire a flat consumption path.
(a) (8 points) Calculate aggregate saving (the flow value that is saved, not the stock) at a given
point in time when the population grows by the factor (1 + n). (Note: There is no income
growth in this economy. Normalize such that the youngest generation has size 1, the second
youngest the third youngest (
2, etc. until the oldest which has size ( (T-l) .)

(b) (7 points) Suppose for simplicity that there are exactly as many working as retirement years
(R = T - R). Compare aggregate saving for an economy with positive population growth
(n > 0). and an economy with no population growth (n = 0). In which economy is aggregate
saving higher? Show formally and explain the result intuitively.

Question 5 ( 19 points)
Consider an economy consisting of two infinitely ljved agents. There is a single non-storable type of
consumption good.
The type 1 agent receives the endowment stream {yf with

yf = {2, 1,2,1,2, 1, ... },

while the type 2 agent receives the endowment stream with

yz = {o, 1,0,1,o, 1, ... }.

Assume· that agents maximize life-time utility 2::: {3tln(c1) Vi= 1, 2.
0
(a) (4 points) A social planner wants to maximize Utilitarian welfare, which means that he would
like to weight both agents equally. He is constrained only by the feasibility of the consumption
allocations. Define the maximization problem of this planner and find the optimal allocation.
(b) (2 points) Is the allocation Pareto efficient? Explain.
(c) (3 points) Now assume that agents maximize life-time utility 2:::
0 ,etzn(cD Vi = 1, 2 and can
trade a full set of Arrow Debreu Securities. A competitive equilibrium is defined as a price
system and allocation {cL s.t.
• Given the price system, the allocation solves each agent's problem.
• The allocation is feasible.
Write down and name the equations for the above described economy that have to be satisfied
in order to establish the competitive equilibrium.

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(d) (7 points) Guess a constant allocation over timeci ci
= c1 , = c2 , and prices = f3t. Find the
values for c1 and c2 . (You do not need to verify that they indeed constitute an equilibrium).
(e) (3 points) Compare the planner allocation to the allocation in the competitive equilibrium. Is
the competitive equilibrium Pareto efficient? Explain intuitively.

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