Economic Growth, year 2015-16

Final exam

Name: Exam A
Group:

Instructions

• This booklet cannot be unstapled. Incomplete booklets will be not graded.

• You have 2 hours to answer this exam.

• Remember to write your name and your group number in the space provided.
• Scholastic dishonesty will not be allowed.
• There are 22 multiple choice questions (66 points) and two exercises (34 points in total).

– Every correct answer in the multiple choice part adds 3 points and each incorrect answer
adds negative, -1 point. Unanswered questions are not counted.
– Mark the correct answer of the multiple choice part in the box below.
– You can use the back of the sheets of this booklet for your calculations.

Answers to multiple choice questions

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
a a a a a a a a a a a a a a a a a a a a
b b b b b b b b b b b b b b b b b b b b
c c c c c c c c c c c c c c c c c c c c
21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40
a a a a a a a a a a a a a a a a a a a a
b b b b b b b b b b b b b b b b b b b b
c c c c c c c c c c c c c c c c c c c c

1
Multiple choice questions (66 points)
1. According to Kaldor
(a) The share of capital income, rt Kt /Yt , has no trend over time.
(b) The share of capital income, rt Kt /Yt , is increasing over time.
(c) The share of capital income, rt Kt /Yt , is decreasing over time.
2. Which of these production functions can represent Gross Domestic Product taking into account the
Kaldor facts and that the capital-labor ratio, Kt /Lt , is increasing over time?
(a) Yt = Kt0.25 L0.75
t + 2 Kt .

−0.5 −2
(b) Yt = 0.3 Kt−0.5 + 0.7 e0.01 t Lt .
(c) Yt = At Kt0.25 L0.65
t .
3. In Gotham, aggregate production can be represented as Yt = Ktα (At ` Nt )1−α . The saving rate is
· ·

s ∈ (0, 1), N At
Nt = n and At = g. ` represents hours worked per capita. Thus, total hours worked are
t

` Nt . At the balanced growth path

(a) Output and capital per capita are constant.
(b) Output and capital per capita grow at the rate g + n.
(c) Output and capital per capita grow at the rate g.
4. in Shem aggregate production can be represented as Yt = Ktα (At ` Nt )1−α . The saving rate is s ∈
· ·

(0, 1), N At gt
Nt = n and At = A e . ` represents hours worked per capita. A permanent reduction in the
t

population growth produces

(a) A permanent fall in the growth rate of output per capita.
(b) A transitory increase in the growth rate of output per capita.
(c) A transitory fall in the level of output per capita.
5. In Vetusta aggregate production can be represented as Yt = Kt0.5 L0.5 t . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. At time t = 0
the stock of capital per worker is k0 = 1. Then, over time
(a) Capital, output, and the wage stay constant.
(b) Capital, output, consumption (per worker) and the wage decrease over time. The real return
of capital increases over time.
(c) Capital, output, consumption (per worker) and the wage grow over time. The real return of
capital decreases over time.
6. Consider two economies, Macondo and Metropolis. In both the technology to produce final good is
0.5
Yt = Kt0.5 (At Lt ) , where s = 0.2 and δ+n = 0.09. The productivity factor is At = e0.01 t . At time t = 0
the stock of capital per worker in Macondo is half of the stock of capital per worker in Metropolis.
(a) Both economies will converge to the same balanced growth path.
(b) The growth rate of output per worker is higher in Metropolis than in Macondo.
(c) Income per capita in Macondo is always half of the income level of the other country.

2
 7. Consider two economies, Rivendel and Rohan. The aggregate production in both economies can be
0.5
represented as Yi t = Ki0.5t (Ai Li t ) . The saving rate is, respectively s = 0.2, and s = 0.3, capital
depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. Both economies
are at their steady state and Rivendel level of income per worker is twice that of Rohan. This implies
that
(a) They have the same level of productivity Ai .
(b) The level of productivity in Rivendel is 3 times the level of productivity in Rohan.
(c) The level of productivity in Rohan is 3 times the level of productivity in Rivendel.
0.5
8. In Kosala, aggregate production can be represented as Yt = Kt0.5 (A Lt ) . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. Kosala, at
time t = 0, is at its steady state. An earthquake destroys half of the stock of capital of the economy at
t = 1. The effect of the earthquake is
(a) A permanent increase in investment.
(b) A reduction in the return to capital.
(c) A sudden fall in the wage, which recovers over time to its previous level.
0.5
9. In Kyrkania, aggregate production can be represented as Yt = Kt0.5 (At Lt ) . The saving rate is
s = 0.2, capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01.
The level of productivity is At = A0 e0.03 t . Kyrkania, at time t = 0, is at its balanced growth path. The
government rises taxes at time t = 1. The effect of such policy is
(a) A permanent reduction in the level of income per worker, a transitory effect on the growth rate
of income per worker.
(b) A permanent reduction in the level of income per worker and the growth rate of income per
worker.
(c) A transitory reduction in the level of income per worker and the growth rate of income per
worker.
α 1−α
10. In Minas Tirith, aggregate production can be represented as Y1t = K1t H1t . The saving rate is
s ∈ (0, 1), capital depreciates at the rate δ ∈ (0, 1) and the level of human capital is H1t = eψ1 u1 L1t .
The labor force, Lt grows at the rate n ∈ (0, 1). The government of Minas Tirith is worried because their
level of income per worker is lower than that of Gaula. That is, Y1t /L1t = 0.5 (Y2t /L2t ). Nevertheless,
the capital to output ratio, Kt /Yt , is the same in both countries. So are the saving rate, depreciation
of capital and the population growth rate. Both countries are at their steady state. So the difference
must be due to
(a) The investment rate.
(b) Minas Tirith grows at a rate lower than that of Gaula.
(c) The schooling technology, ψ, is better in Gaula than in Minas Tirith.
11. In Narnia, aggregate production can be represented as Yt = Kt0.5 L0.5 t . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. Narnia, at
time t = 0, is at its steady state. The government liberalizes markets so that the saving rate increases
to s = 0.4. Then:
(a) Consumption falls and increases until it reaches a new higher steady state level.
(b) Consumption increases permanently.
(c) Consumption decreases permanently.

3
 0.5
12. In Avra, production can be represented as Yt = Kt0.5 (At Lt ) , where the productivity factor depends
on the amount of capital per worker At = A kt , where kt is capital per capita. Population is constant,
Nt = Lt = 1. The saving rate is s = 0.3, capital depreciates at the rate δ ∈ (0, 1), and s A > δ. The
growth rate of income per worker at the balanced growth path is
(a) n.
(b) s A − δ.
(c) s − δ.
0.5
13. In Cólquide, production can be represented as Yt = Kt0.5 (At Lt ) , where the productivity factor
depends on the amount of capital per worker At = kt , where kt is capital per capita. Population is
constant, Nt = Lt = 1. The saving rate is s = 0.3, capital depreciates at the rate δ = 0.1. The
government imposes a tax rate τ = 0.1 over income. The change in the growth rate of income at the
balanced growth path is
(a) 0.03.
(b) −0.03.
(c) 0.17.
0.5
14. In Cimmeria, production per worker can be represented as yt = kt0.5 (At Lt ) , where the productivity
factor depends on the amount of capital per worker At = kt . Population is constant. The saving rate
is s = 0.3, capital depreciates at the rate δ = 0.1. An earthquake destroys half of the stock of capital
of the economy at t = 1. The effect of the earthquake is
(a) A permanent increase in investment.
(b) A transitory increase in the growth rate of income, leaving its long run level unaffected.
(c) A permanent reduction in the level of income, leaving its growth rate unaffected.
 0.2
15. In Micomicón, production per worker can be represented as At kt0.5 NTt `0.3 , the productivity factor,
At , grows at the rate γ ∈ (0.1). The saving rate is s = 0.3, capital depreciates at the rate δ = 0.1. The
workforce grows at the rate n = 0.01. For the growth rate of income per capita in Micomicón to be
positive in the long run, the growth rate of productivity, γ should be higher than
(a) 2%.
(b) 1%.
(c) 0%.
16. In Acheron, production per worker can be represented as yt = At ktα mθt `1−α−θ , the productivity factor,
At , grows at the rate γ ∈ (0.1). The amount of energy used (in per capita terms), mt , is a constant
fraction of the stock of oil, mt =  ρt , where the evolution of the stock in per capita terms is ρt =
ρ0 e−(+n)t . The stock of oil is owned by the State of Acheron. The extraction rate is . The government
of Acheron wants to double the extraction rate. The effect is going to be
(a) An increase in the growth rate of income in the short and the long run.
(b) An increase in the level of income per capita in the short run, a lower growth rate of income
per capita in the long run.
(c) An increase in the level of income per capita in the long run, a lower growth rate of income per
capita in the short run.

4
 1−α
17. In Zamora, production per worker can be represented as yt = ktα (At `Y ) , the productivity factor,
η
At , depends on the level of Research and Development; Ȧt = φ Aγt (`A Lt ) . Population Lt grows at a
constant rate n. `Y + `A = 1. Assume that the economy is at its balanced growth path. The effect of
a permanent fall in the fraction of the labor force that works in the R&D sector is
(a) A transitory fall in the level of innovation.
(b) A sudden fall in the growth rate of innovation and a permanent reduction in the level of inno-
vation.
(c) A permanent decrease in the growth rate of innovation.
R At α
18. In Brithunia, production per worker can be represented as yt = `1−αYt 0
xjt d j, the level of innovation,
η
At , is given by Ȧt = φ Aγt (`At Lt ) . The production of the intermediate goods xjt needs of capital,
xjt ≤ kjt , and paying the price of the patent of the idea, Qt . The patent has no time limit. Population
Lt grows at a constant rate n. `Y t + `At = 1. Assume that the economy is at its balanced growth path.
In this economy
(a) The level of innovation is efficient.
(b) The level of innovation is higher than the socially optimal level.
(c) The level of innovation is lower than the socially optimal level.
19. The technological level of Theed grows at a constant rate, At = A eg t . The level of adoption in Mos
Eisley evolves according to the law ḣt = φ Aγt hθt , and γ + θ < 1. In the long run
(a) Productivity in Mos Eisley will grow at a lower rate than productivity in Theed.
(b) Productivity in Mos Eisley will grow at a higher rate than productivity in Theed.
(c) Productivity in Mos Eisley will grow at the same rate than productivity inTheed.
20. In Nemedia aggregate production can be represented as Yt = Kt0.5 L0.5 t . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. At time t = 0
the stock of capital per worker is k0 = 1. In Pictos, the saving rate is s = 0.3. Both economies are at
their steady state. Suppose now that both economies open their capital markets, so that capital can
flow from one country to another one. Then,
(a) The return to capital is the same in both countries and, therefore, it does not move.
(b) Capital flows from Pictos to Nemedia.
(c) Capital flows from Nemedia to Pictos.
R At α
21. In Shem, production per worker can be represented as yt = `1−α Yt 0
xjt d j, the level of innovation,
η
At , is given by Ȧt = φ Aγt (`At Lt ) . The production of the intermediate goods xjt needs of capital,
xjt ≤ kjt , and paying the price of the patent of the idea, Qt . The patent has no time limit. Population
Lt grows at a constant rate n. `Y t + `At = 1. Assume that the economy is at its balanced growth path.
A new government reduces the life of the patent from infinity to 20 years, time after which anyone can
use the design. Then, in the long run,
(a) The level of innovation stays constant.
(b) The level of innovation increases.
(c) The level of innovation decreases.
22. In Benejuzar the stock of capital is twice the level in Bigastro. Nevertheless, the return to capital is the
same in both countries. This is because
(a) The level of productivity in Bigastro is the same that in Benejuzar.
(b) The level of productivity in Bigastro is higher than in Benejuzar.
(c) The level of productivity in Bigastro is lower than in Benejuzar.

5
Exercises. Provide clear and concise answers and explain the economic meaning of your results.
23. In Oleza the aggregate production needs of capital and labor according to the production function,
1/3 2/3
Yt = Kt (At Lt ) . Capital depreciates at the rate δ ∈ (0, 1) and the population growth rate is
L̇t
Lt = n ∈ (0, 1). To simplify the calculus, assume that Lt = Nt . The investment rate is s ∈ (0, 1).
The productivity level evolves according to the function Ȧt = n A1−2 t
ψ ψ
Dt , where ψ ∈ (0, 1), and
0 < 1 − 2 ψ < 1. Dt denotes aggregate expenditure in R&D, Dt = d Nt yt , where d ∈ (0, 1). Capital
evolves according to the law K̇t = s Yt − δ Kt . The per capita level of consumption is ct = (1 − s − d)yt .

(a) Obtain the growth rate of output per capita and capital per capita at the balanced growth path.
Proceed as follows:
i. Apply the definition of balanced growth path and write the growth rate of output per capita at
the BGP as a function of the growth rate of the stock of ideas. (2 points)
ii. Now use the law of motion of the stock of ideas, Ȧt = n A1−2
t
ψ ψ
Dt , and find the growth rate
of At at the BGP as a function of parameters. (2 points)
0.5
(b) At the balanced growth path, the stock of knowledge is A∗t = (d Nt yt∗ ) . Find the level of capital,
income and consumption at the BGP. Proceed as follows:
i. Use the production function in per capita terms and write output per capita as a function of
capital and population, Nt (not At ). (2 points)
ii. Now use the law of motion of capital and find the level of capital, income and consumption at
the BGP. (2 points)
(c) Find the optimal rate, d∗ , of expenditures in R&D. (4 points)
(d) In Oleza the rate of expenditures in R&D is below d∗ . Suppose that you can convince the Minister
of Science and Innovation to rise d to the optimal level d∗ . Argue (in words) what will be the effect
on the evolution of consumption in per capital levels, in the short and the long run. (4 points)
24. Consider an economy that produces two goods, an agricultural good and a manufacturing good.
An amount YA t of the agricultural good is produced with land, T , and labor according to Y A t =
θ 1−θ
T (Bt LA t ) . The manufacturing good is produced with the technology YM t = Bt LM t , and LA,t +
LM t = Lt . For simplicity assume that the amount of available land is one, T = 1. Productivity and
population are growing over time, Bt = B eγ t and Lt = L en t .
(a) Assume that the relative price of the agricultural goods (in units of manufacturing goods) is one.
Define `A t = LA t /Lt as the fraction of the labor force working in the agricultural sector.
i. Find the allocation `∗A t that equates the wage across sectors. Remember that the wage, in
equilibrium, must be equal to the marginal productivity of labor. Explain (with words) why the
labor share in the agricultural sector may change (or not) over time. (3 points)
ii. Total GDP is GDPt = YA t + YM t . Show the evolution of GDP over time. (3 points)
iii. Let the price of the land pTt be given by the marginal productivity of land. What happens to
the share of land, pTt T /GDPt ? (3 points)
(b) Assume now that the relative price of agricultural goods (in units of manufacturing goods) is equal
to pA t = φ YYM
At
t
. That is, it varies with the amount produced of each type of good.
i. Find the allocation `∗A t that equates the wage across sectors. Remember that the wage, in
equilibrium, must be equal to the marginal productivity of labor. Explain (with words) why
the labor share in the agricultural sector may change (or not) over time. HINT: You have to
calculate the wage in each sector given the relative price of the agricultural good, pA t , and
substitute the expression of the relative price afterwards. (3 points)
ii. Total GDP is GDPt = pA t YA t + YM t . Show the evolution of GDP over time. (3 points)
iii. Let the price of the land pTt be given by the marginal productivity of land. What happens to
the share of land, pTt T /GDPt ? (3 points)

6
 Economic Growth, year 2015-16
Final exam answer key

Nombre: Versión A
Grupo:

Multiple choice questions (66 points)

1. According to Kaldor
(a) The share of capital income, rt Kt /Yt , has no trend over time.
(b) The share of capital income, rt Kt /Yt , is increasing over time.
(c) The share of capital income, rt Kt /Yt , is decreasing over time.
2. Which of these production functions can represent Gross Domestic Product taking into account the
Kaldor facts and that the capital-labor ratio, Kt /Lt , is increasing over time?
(a) Yt = Kt0.25 L0.75
t + 2 Kt .

−0.5 −2
(b) Yt = 0.3 Kt−0.5 + 0.7 e0.01 t Lt .
(c) Yt = At Kt0.25 L0.65
t .
3. In Gotham, aggregate production can be represented as Yt = Ktα (At ` Nt )1−α . The saving rate is
· ·

s ∈ (0, 1), N At
Nt = n and At = g. ` represents hours worked per capita. Thus, total hours worked are
t

` Nt . At the balanced growth path

(a) Output and capital per capita are constant.
(b) Output and capital per capita grow at the rate g + n.
(c) Output and capital per capita grow at the rate g.
4. in Shem aggregate production can be represented as Yt = Ktα (At ` Nt )1−α . The saving rate is s ∈
· ·

(0, 1), N At gt
Nt = n and At = A e . ` represents hours worked per capita. A permanent reduction in the
t

population growth produces

(a) A permanent fall in the growth rate of output per capita.
(b) A transitory increase in the growth rate of output per capita.
(c) A transitory fall in the level of output per capita.

1
5. In Vetusta aggregate production can be represented as Yt = Kt0.5 L0.5 t . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. At time t = 0
the stock of capital per worker is k0 = 1. Then, over time
(a) Capital, output, and the wage stay constant.
(b) Capital, output, consumption (per worker) and the wage decrease over time. The real return
of capital increases over time.
(c) Capital, output, consumption (per worker) and the wage grow over time. The real return of
capital decreases over time.
6. Consider two economies, Macondo and Metropolis. In both the technology to produce final good is
0.5
Yt = Kt0.5 (At Lt ) , where s = 0.2 and δ+n = 0.09. The productivity factor is At = e0.01 t . At time t = 0
the stock of capital per worker in Macondo is half of the stock of capital per worker in Metropolis.
(a) Both economies will converge to the same balanced growth path.
(b) The growth rate of output per worker is higher in Metropolis than in Macondo.
(c) Income per capita in Macondo is always half of the income level of the other country.
7. Consider two economies, Rivendel and Rohan. The aggregate production in both economies can be
0.5
represented as Yi t = Ki0.5t (Ai Li t ) . The saving rate is, respectively s = 0.2, and s = 0.3, capital
depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. Both economies
are at their steady state and Rivendel level of income per worker is twice that of Rohan. This implies
that
(a) They have the same level of productivity Ai .
(b) The level of productivity in Rivendel is 3 times the level of productivity in Rohan.
(c) The level of productivity in Rohan is 3 times the level of productivity in Rivendel.
0.5
8. In Kosala, aggregate production can be represented as Yt = Kt0.5 (A Lt ) . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. Kosala, at
time t = 0, is at its steady state. An earthquake destroys half of the stock of capital of the economy at
t = 1. The effect of the earthquake is
(a) A permanent increase in investment.
(b) A reduction in the return to capital.
(c) A sudden fall in the wage, which recovers over time to its previous level.
0.5
9. In Kyrkania, aggregate production can be represented as Yt = Kt0.5 (At Lt ) . The saving rate is
s = 0.2, capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01.
The level of productivity is At = A0 e0.03 t . Kyrkania, at time t = 0, is at its balanced growth path. The
government rises taxes at time t = 1. The effect of such policy is
(a) A permanent reduction in the level of income per worker, a transitory effect on the growth rate
of income per worker.
(b) A permanent reduction in the level of income per worker and the growth rate of income per
worker.
(c) A transitory reduction in the level of income per worker and the growth rate of income per
worker.

2
 α 1−α
10. In Minas Tirith, aggregate production can be represented as Y1t = K1t H1t . The saving rate is
s ∈ (0, 1), capital depreciates at the rate δ ∈ (0, 1) and the level of human capital is H1t = eψ1 u1 L1t .
The labor force, Lt grows at the rate n ∈ (0, 1). The government of Minas Tirith is worried because their
level of income per worker is lower than that of Gaula. That is, Y1t /L1t = 0.5 (Y2t /L2t ). Nevertheless,
the capital to output ratio, Kt /Yt , is the same in both countries. So are the saving rate, depreciation
of capital and the population growth rate. Both countries are at their steady state. So the difference
must be due to
(a) The investment rate.
(b) Minas Tirith grows at a rate lower than that of Gaula.
(c) The schooling technology, ψ, is better in Gaula than in Minas Tirith.
11. In Narnia, aggregate production can be represented as Yt = Kt0.5 L0.5 t . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. Narnia, at
time t = 0, is at its steady state. The government liberalizes markets so that the saving rate increases
to s = 0.4. Then:
(a) Consumption falls and increases until it reaches a new higher steady state level.
(b) Consumption increases permanently.
(c) Consumption decreases permanently.
0.5
12. In Avra, production can be represented as Yt = Kt0.5 (At Lt ) , where the productivity factor depends
on the amount of capital per worker At = A kt , where kt is capital per capita. Population is constant,
Nt = Lt = 1. The saving rate is s = 0.3, capital depreciates at the rate δ ∈ (0, 1), and s A > δ. The
growth rate of income per worker at the balanced growth path is
(a) n.
(b) s A − δ.
(c) s − δ.
0.5
13. In Cólquide, production can be represented as Yt = Kt0.5 (At Lt ) , where the productivity factor
depends on the amount of capital per worker At = kt , where kt is capital per capita. Population is
constant, Nt = Lt = 1. The saving rate is s = 0.3, capital depreciates at the rate δ = 0.1. The
government imposes a tax rate τ = 0.1 over income. The change in the growth rate of income at the
balanced growth path is
(a) 0.03.
(b) −0.03.
(c) 0.17.
0.5
14. In Cimmeria, production per worker can be represented as yt = kt0.5 (At Lt ) , where the productivity
factor depends on the amount of capital per worker At = kt . Population is constant. The saving rate
is s = 0.3, capital depreciates at the rate δ = 0.1. An earthquake destroys half of the stock of capital
of the economy at t = 1. The effect of the earthquake is
(a) A permanent increase in investment.
(b) A transitory increase in the growth rate of income, leaving its long run level unaffected.
(c) A permanent reduction in the level of income, leaving its growth rate unaffected.

3
  0.2
T
15. In Micomicón, production per worker can be represented as At kt0.5 Nt `0.3 , the productivity factor,
At , grows at the rate γ ∈ (0.1). The saving rate is s = 0.3, capital depreciates at the rate δ = 0.1. The
workforce grows at the rate n = 0.01. For the growth rate of income per capita in Micomicón to be
positive in the long run, the growth rate of productivity, γ should be higher than
(a) 2%.
(b) 1%.
(c) 0%.
16. In Acheron, production per worker can be represented as yt = At ktα mθt `1−α−θ , the productivity factor,
At , grows at the rate γ ∈ (0.1). The amount of energy used (in per capita terms), mt , is a constant
fraction of the stock of oil, mt =  ρt , where the evolution of the stock in per capita terms is ρt =
ρ0 e−(+n)t . The stock of oil is owned by the State of Acheron. The extraction rate is . The government
of Acheron wants to double the extraction rate. The effect is going to be
(a) An increase in the growth rate of income in the short and the long run.
(b) An increase in the level of income per capita in the short run, a lower growth rate of income
per capita in the long run.
(c) An increase in the level of income per capita in the long run, a lower growth rate of income per
capita in the short run.
1−α
17. In Zamora, production per worker can be represented as yt = ktα (At `Y ) , the productivity factor,
η
At , depends on the level of Research and Development; Ȧt = φ Aγt (`A Lt ) . Population Lt grows at a
constant rate n. `Y + `A = 1. Assume that the economy is at its balanced growth path. The effect of
a permanent fall in the fraction of the labor force that works in the R&D sector is
(a) A transitory fall in the level of innovation.
(b) A sudden fall in the growth rate of innovation and a permanent reduction in the level of inno-
vation.
(c) A permanent decrease in the growth rate of innovation.
R At α
18. In Brithunia, production per worker can be represented as yt = `1−αYt 0
xjt d j, the level of innovation,
η
At , is given by Ȧt = φ Aγt (`At Lt ) . The production of the intermediate goods xjt needs of capital,
xjt ≤ kjt , and paying the price of the patent of the idea, Qt . The patent has no time limit. Population
Lt grows at a constant rate n. `Y t + `At = 1. Assume that the economy is at its balanced growth path.
In this economy
(a) The level of innovation is efficient.
(b) The level of innovation is higher than the socially optimal level.
(c) The level of innovation is lower than the socially optimal level.
19. The technological level of Theed grows at a constant rate, At = A eg t . The level of adoption in Mos
Eisley evolves according to the law ḣt = φ Aγt hθt , and γ + θ < 1. In the long run
(a) Productivity in Mos Eisley will grow at a lower rate than productivity in Theed.
(b) Productivity in Mos Eisley will grow at a higher rate than productivity in Theed.
(c) Productivity in Mos Eisley will grow at the same rate than productivity inTheed.

4
 20. In Nemedia aggregate production can be represented as Yt = Kt0.5 L0.5 t . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. At time t = 0
the stock of capital per worker is k0 = 1. In Pictos, the saving rate is s = 0.3. Both economies are at
their steady state. Suppose now that both economies open their capital markets, so that capital can
flow from one country to another one. Then,
(a) The return to capital is the same in both countries and, therefore, it does not move.
(b) Capital flows from Pictos to Nemedia.
(c) Capital flows from Nemedia to Pictos.
R At α
21. In Shem, production per worker can be represented as yt = `1−α Yt 0
xjt d j, the level of innovation,
γ η
At , is given by Ȧt = φ At (`At Lt ) . The production of the intermediate goods xjt needs of capital,
xjt ≤ kjt , and paying the price of the patent of the idea, Qt . The patent has no time limit. Population
Lt grows at a constant rate n. `Y t + `At = 1. Assume that the economy is at its balanced growth path.
A new government reduces the life of the patent from infinity to 20 years, time after which anyone can
use the design. Then, in the long run,
(a) The level of innovation stays constant.
(b) The level of innovation increases.
(c) The level of innovation decreases.
22. In Benejuzar the stock of capital is twice the level in Bigastro. Nevertheless, the return to capital is the
same in both countries. This is because
(a) The level of productivity in Bigastro is the same that in Benejuzar.
(b) The level of productivity in Bigastro is higher than in Benejuzar.
(c) The level of productivity in Bigastro is lower than in Benejuzar.

Exercises. Provide clear and concise answers and explain the economic meaning of your results.
23. In Oleza the aggregate production needs of capital and labor according to the production function,
1/3 2/3
Yt = Kt (At Lt ) . Capital depreciates at the rate δ ∈ (0, 1) and the population growth rate is
L̇t
Lt = n ∈ (0, 1). To simplify the calculus, assume that Lt = Nt . The investment rate is s ∈ (0, 1).
The productivity level evolves according to the function Ȧt = n A1−2 t
ψ ψ
Dt , where ψ ∈ (0, 1), and
0 < 1 − 2 ψ < 1. Dt denotes aggregate expenditure in R&D, Dt = d Nt yt , where d ∈ (0, 1). Capital
evolves according to the law K̇t = s Yt − δ Kt . The per capita level of consumption is ct = (1 − s − d)yt .
(a) Obtain the growth rate of output per capita and capital per capita at the balanced growth path.
Proceed as follows:
i. Apply the definition of balanced growth path and write the growth rate of output per capita at
the BGP as a function of the growth rate of the stock of ideas. (2 points)
1/3 2/3
Answer: The production function in per capita terms is yt = kt At . Thus, taking logs and
differentiating with respect to time, ẏytt = 13 k̇ktt + 23 A
Ȧt
t
. At the balanced growth path (BGP
ẏ ∗ k̇∗ Ȧ∗
hereafter), output and capital should grow at the same rate. Thus, yt∗ = kt∗ = At∗ = g,
t t t
where g is still unknown.
ii. Now use the law of motion of the stock of ideas, Ȧt = n A1−2
t
ψ ψ
Dt , and find the growth rate
of At at the BGP as a function of parameters. (2 points)
Ȧ∗ −2 ψ ψ
Answer: The growth rate of ideas of ideas in the BGP is A∗
t
= n (A∗t ) (d Nt yt∗ ) , which
t
−2 ψ ψ
is g = n (A∗t ) (d Nt yt∗ ) . taking logs and differentiating wth respect to time, 0 =
Ȧ∗ ẏt∗
−2 ψ A∗+ ψ n + ψ . Since the growth rate of innovation and output per capita are equal
t
yt∗
t
at the BGP, it follows that g = n.

5
 0.5
(b) At the balanced growth path, the stock of knowledge is A∗t = (d Nt yt∗ ) . Find the level of capital,
income and consumption at the BGP. Proceed as follows:
i. Use the production function in per capita terms and write output per capita as a function of
capital and population, Nt (not At ). (2 points)
0.5
Answer: You can check that, indeed, at the BGP A∗t = (d Nt yt∗ ) . Now substitute this ex-
pression in the production function (I am omitting the ∗ to not clutter the writing), yt =
 2/3
1/3 2/3 1/3 0.5 1/3 1/3 2/3
k t At = kt (d Nt yt∗ ) , hence yt = kt ((d Nt yt∗ )) , simplifying, yt =
1/3 1/3 0.5
kt (d Nt ) , hence yt = kt0.5 (d Nt ) .
ii. Now use the law of motion of capital and find the level of capital, income and consumption at
the BGP. (2 points)
Answer: The law of motion of capital, in per capita terms, is k˙t = s yt −(δ+n)kt . Substituting,
0.5
k̇t = s kt0.5 (d Nt ) − (δ + n)kt . At the BGP, k̇t = g kt . Recall, g = n. Thus, at the BGP,
 2  
0.5
n kt = s kt0.5 (d Nt ) − (δ + n)kt . Thus, kt∗ = delta+2 s
n d Nt , yt
∗
= s
delta+2 n d Nt ,
 
and c∗t = (1 − s − d) δ+2 n d Nt .
s

(c) Find the optimal rate, d∗ , of expenditures in R&D. (4 points)

Answer: Maximizing c∗t with respect to d amounts to maximizing (1 − s − d)d. Hence, d∗ = 1−s 2 .
That is, Oleza should invest in R&D activities the fraction 1−s2 of its total GDP.
(d) In Oleza the rate of expenditures in R&D is below d∗ . Suppose that you can convince the Minister
of Science and Innovation to rise d to the optimal level d∗ . Argue (in words) what will be the effect
on the evolution of consumption in per capital levels, in the short and the long run. (4 points)
Answer: We could think of d∗ as a golden rule for investment in R&D. If we increase our expen-
ditures in R&D to d∗ , the effect of this policy on consumption should qualitatively the same
that the effect of increasing the saving rate to the golden rule. In the short run, consumption
falls and it rises to a new balanced growth path with a higher level of consumption.
24. Consider an economy that produces two goods, an agricultural good and a manufacturing good.
An amount YA t of the agricultural good is produced with land, T , and labor according to Y A t =
θ 1−θ
T (Bt LA t ) . The manufacturing good is produced with the technology YM t = Bt LM t , and LA,t +
LM t = Lt . For simplicity assume that the amount of available land is one, T = 1. Productivity and
population are growing over time, Bt = B eγ t and Lt = L en t .
(a) Assume that the relative price of the agricultural goods (in units of manufacturing goods) is one.
Define `A t = LA t /Lt as the fraction of the labor force working in the agricultural sector.
i. Find the allocation `∗A t that equates the wage across sectors. Remember that the wage, in
equilibrium, must be equal to the marginal productivity of labor. Explain (with words) why the
labor share in the agricultural sector may change (or not) over time. (3 points)
Answer: Since labor is mobile across sectors, the wage must be equal in both sectors. In an
competitive economy, the wage equals the marginal productivity of labor. Thus, Bt = (1−
(1−θ)f rac1θ
Bt−1
θ)Bt1−θ L−θ
At . Hence, LAt = (1 − θ)
f rac1θ −1
Bt and, therefore, `At ≡ LAt
Lt = Lt .
(1−θ)f rac1θ −(γ+n)t
Given the expressions of Bt and Lt , we can write `At = BL e . Hence, the
absolute level of workers in the agricultural sector falls because productivity in the agri-
cultural sector grows at the rate θ gamma, whereas productivity in manufacturing grows
at the rate γ. That is, if the employment size of both sectors were equal, the wage of man-
ufacturing would rise faster than the wage in the agricultural sector. Hence, employment
in the agricultural sector must fall over time.
ii. Total GDP is GDPt = YA t + YM t . Show the evolution of GDP over time. (3 points)

1−θ
Answer: YAt = Bt (1 − θ)f rac1θ Bt−1 , hence YAt = (1 − θ)f rac1−θθ . Since LM t = Lt −
1 1
LAt , then YM t = Bt Lt − (1 − θ) θ . Thus, adding up, GDPt = Bt Lt − (1 − θ) θ + (1 −
θ)f rac1−θθ . Simplifying, GDPt = Bt Lt + (1 − θ)f rac1θ . It increases over time, at a lower
rate than output in the manufacturing sector.

6
 iii. Let the price of the land pTt be given by the marginal productivity of land. What happens to
the share of land, pTt T /GDPt ? (3 points)
θ−1 1−θ
Answer: The price of land must be equal to its marginal productivity, pTt = θ T (Bt LA t ) .
pT
T YAt
Hence, pTtT = θ YAt . Thus, t
GDPt =θ GDPt .This share is decreasing over time, since
output of the agricultural sector, as a fraction of GDP, falls over time.
(b) Assume now that the relative price of agricultural goods (in units of manufacturing goods) is equal
to pA t = φ YYM
At
t
. That is, it varies with the amount produced of each type of good.
i. Find the allocation `∗A t that equates the wage across sectors. Remember that the wage, in
equilibrium, must be equal to the marginal productivity of labor. Explain (with words) why
the labor share in the agricultural sector may change (or not) over time. HINT: You have to
calculate the wage in each sector given the relative price of the agricultural good, pA t , and
substitute the expression of the relative price afterwards. (3 points)
Answer: The wage must be equal across sectors. Thus, wt = ∂ YM t /∂ LM t and wt =
∂ pAt YAt /∂ LAt . Hence, wt = Bt and wt = pAt (1 − θ)Bt1−θ L−θ At . Marginal productivity of
YAt
labor in the agricultural sector can be written as wt = pAt (1 − θ) L At
. Taking into account
YM t
that pA t = φ YA t , and substituting in the expression for the marginal productivity of labor
in the agricultural sector, wt = φ(1 − θ) YLM t
At
. Thus, equating the wage across sectors,
φ(1−θ)
Bt = (1 − θ) YLM t
At
. Since YM t = Bt LM t , then 1 = φ(1 − θ) LLM t
At
, and LAt /Lt = 1+φ(1−θ) .
Thus, the share of labor in the agricultural sector is constant over time. This is so because
the relative price of agricultural goods is rising over time.
ii. Total GDP is GDPt = pA t YA t + YM t . Show the evolution of GDP over time. (3 points)
Answer: Notice that substituting the expression for the relative price of agricultural goods,
Bt Lt
GDPt = (1 + φ)YM t , thus, GDP = 1+φ(1−θ) . GDP grows at the same rate that output in
the manufacturing sector.
iii. Let the price of the land pTt be given by the marginal productivity of land. What happens to
the share of land, pTt T /GDPt ? (3 points)
θ−1 1−θ
Answer: The price of land must be equal to its marginal productivity, pTt = pAt θ T (Bt LA t ) .
pT T θ
Hence, pTt T = pAt θ YAt = θ YM t . Thus, GDPt = 1+φ
t
. This share is constant over time,
since output of the agricultural sector, as a fraction of GDP, is constant over time.

7
 Economic Growth, year 2015-16
Final exam

Name: Exam B
Group:

Instructions

• This booklet cannot be unstapled. Incomplete booklets will be not graded.

• You have 2 hours to answer this exam.

• Remember to write your name and your group number in the space provided.
• Scholastic dishonesty will not be allowed.
• There are 22 multiple choice questions (66 points) and two exercises (34 points in total).

– Every correct answer in the multiple choice part adds 3 points and each incorrect answer
adds negative, -1 point. Unanswered questions are not counted.
– Mark the correct answer of the multiple choice part in the box below.
– You can use the back of the sheets of this booklet for your calculations.

Answers to multiple choice questions

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
a a a a a a a a a a a a a a a a a a a a
b b b b b b b b b b b b b b b b b b b b
c c c c c c c c c c c c c c c c c c c c
21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40
a a a a a a a a a a a a a a a a a a a a
b b b b b b b b b b b b b b b b b b b b
c c c c c c c c c c c c c c c c c c c c

1
Multiple choice questions (66 points)
1. According to Kaldor
(a) The share of capital income, rt Kt /Yt , has no trend over time.
(b) The share of capital income, rt Kt /Yt , is increasing over time.
(c) The share of capital income, rt Kt /Yt , is decreasing over time.
2. Which of these production functions can represent Gross Domestic Product taking into account the
Kaldor facts and that the capital-labor ratio, Kt /Lt , is increasing over time?
(a) Yt = Kt0.25 L0.75
t + 2 Kt .

−0.5 −2
(b) Yt = 0.3 Kt−0.5 + 0.7 e0.01 t Lt .
(c) Yt = At Kt0.25 L0.65
t .
3. In Genosha, aggregate production can be represented as Yt = Ktα (At ` Nt )1−α . The saving rate is
· ·

s ∈ (0, 1), N At
Nt = n and At = g. ` represents hours worked per capita. Thus, total hours worked are
t

` Nt . At the balanced growth path

(a) Output and capital per capita are constant.
(b) Output and capital per capita grow at the rate g + n.
(c) Output and capital per capita grow at the rate g.
4. in Estigia aggregate production can be represented as Yt = Ktα (At ` Nt )1−α . The saving rate is s ∈
· ·

(0, 1), N At gt
Nt = n and At = A e . ` represents hours worked per capita. A permanent reduction in the
t

population growth produces

(a) A permanent fall in the growth rate of output per capita.
(b) A transitory increase in the growth rate of output per capita.
(c) A transitory fall in the level of output per capita.
5. In Oleza aggregate production can be represented as Yt = Kt0.5 L0.5
t . The saving rate is s = 0.2, capital
depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. At time t = 0 the
stock of capital per worker is k0 = 1. Then, over time
(a) Capital, output, and the wage stay constant.
(b) Capital, output, consumption (per worker) and the wage decrease over time. The real return
of capital increases over time.
(c) Capital, output, consumption (per worker) and the wage grow over time. The real return of
capital decreases over time.
6. Consider two economies, Yoknapatawpha and Neopolis. In both the technology to produce final good
0.5
is Yt = Kt0.5 (At Lt ) , where s = 0.2 and δ + n = 0.09. The productivity factor is At = e0.01 t . At
time t = 0 the stock of capital per worker in Yoknapatawpha is half of the stock of capital per worker in
Neopolis.
(a) Both economies will converge to the same balanced growth path.
(b) The growth rate of output per worker is higher in Neopolis than in Yoknapatawpha.
(c) Income per capita in Yoknapatawpha is always half of the income level of the other country.

2
 7. Consider two economies, Tharbad and Bree. The aggregate production in both economies can be
0.5
represented as Yi t = Ki0.5t (Ai Li t ) . The saving rate is, respectively s = 0.2, and s = 0.3, capital
depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. Both economies are
at their steady state and Tharbad level of income per worker is twice that of Bree. This implies that
(a) They have the same level of productivity Ai .
(b) The level of productivity in Tharbad is 3 times the level of productivity in Bree.
(c) The level of productivity in Bree is 3 times the level of productivity in Tharbad.
0.5
8. In Vendhya, aggregate production can be represented as Yt = Kt0.5 (A Lt ) . The saving rate is
s = 0.2, capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01.
Vendhya, at time t = 0, is at its steady state. An earthquake destroys half of the stock of capital of the
economy at t = 1. The effect of the earthquake is
(a) A permanent increase in investment.
(b) A reduction in the return to capital.
(c) A sudden fall in the wage, which recovers over time to its previous level.
0.5
9. In Turan, aggregate production can be represented as Yt = Kt0.5 (At Lt ) . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. The level
of productivity is At = A0 e0.03 t . Turan, at time t = 0, is at its balanced growth path. The government
rises taxes at time t = 1. The effect of such policy is
(a) A permanent reduction in the level of income per worker, a transitory effect on the growth rate
of income per worker.
(b) A permanent reduction in the level of income per worker and the growth rate of income per
worker.
(c) A transitory reduction in the level of income per worker and the growth rate of income per
worker.
α 1−α
10. In Osgiliath, aggregate production can be represented as Y1t = K1t H1t . The saving rate is s ∈ (0, 1),
capital depreciates at the rate δ ∈ (0, 1) and the level of human capital is H1t = eψ1 u1 L1t . The labor
force, Lt grows at the rate n ∈ (0, 1). The government of Osgiliath is worried because their level of
income per worker is lower than that of Tarascón. That is, Y1t /L1t = 0.5 (Y2t /L2t ). Nevertheless, the
capital to output ratio, Kt /Yt , is the same in both countries. So are the saving rate, depreciation of
capital and the population growth rate. Both countries are at their steady state. So the difference must
be due to
(a) The investment rate.
(b) Osgiliath grows at a rate lower than that of Tarascón.
(c) The schooling technology, ψ, is better in Tarascón than in Osgiliath.
11. In Archenland, aggregate production can be represented as Yt = Kt0.5 Lt0.5 . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. Archenland,
at time t = 0, is at its steady state. The government liberalizes markets so that the saving rate increases
to s = 0.4. Then:
(a) Consumption falls and increases until it reaches a new higher steady state level.
(b) Consumption increases permanently.
(c) Consumption decreases permanently.

3
 0.5
12. In Doorn, production can be represented as Yt = Kt0.5 (At Lt ) , where the productivity factor depends
on the amount of capital per worker At = A kt , where kt is capital per capita. Population is constant,
Nt = Lt = 1. The saving rate is s = 0.3, capital depreciates at the rate δ ∈ (0, 1), and s A > δ. The
growth rate of income per worker at the balanced growth path is
(a) n.
(b) s A − δ.
(c) s − δ.
0.5
13. In Atlantida, production can be represented as Yt = Kt0.5 (At Lt ) , where the productivity factor de-
pends on the amount of capital per worker At = kt , where kt is capital per capita. Population is
constant, Nt = Lt = 1. The saving rate is s = 0.3, capital depreciates at the rate δ = 0.1. The
government imposes a tax rate τ = 0.1 over income. The change in the growth rate of income at the
balanced growth path is
(a) 0.03.
(b) −0.03.
(c) 0.17.
0.5
14. In Corinthia, production per worker can be represented as yt = kt0.5 (At Lt ) , where the productivity
factor depends on the amount of capital per worker At = kt . Population is constant. The saving rate
is s = 0.3, capital depreciates at the rate δ = 0.1. An earthquake destroys half of the stock of capital
of the economy at t = 1. The effect of the earthquake is
(a) A permanent increase in investment.
(b) A transitory increase in the growth rate of income, leaving its long run level unaffected.
(c) A permanent reduction in the level of income, leaving its growth rate unaffected.
 0.2
15. In Barataria, production per worker can be represented as At kt0.5 NTt `0.3 , the productivity factor,
At , grows at the rate γ ∈ (0.1). The saving rate is s = 0.3, capital depreciates at the rate δ = 0.1.
The workforce grows at the rate n = 0.01. For the growth rate of income per capita in Barataria to be
positive in the long run, the growth rate of productivity, γ should be higher than
(a) 2%.
(b) 1%.
(c) 0%.
16. In Aquilonia, production per worker can be represented as yt = At ktα mθt `1−α−θ , the productivity factor,
At , grows at the rate γ ∈ (0.1). The amount of energy used (in per capita terms), mt , is a constant
fraction of the stock of oil, mt =  ρt , where the evolution of the stock in per capita terms is ρt =
ρ0 e−(+n)t . The stock of oil is owned by the State of Aquilonia. The extraction rate is . The government
of Aquilonia wants to double the extraction rate. The effect is going to be
(a) An increase in the growth rate of income in the short and the long run.
(b) An increase in the level of income per capita in the short run, a lower growth rate of income
per capita in the long run.
(c) An increase in the level of income per capita in the long run, a lower growth rate of income per
capita in the short run.

4
 1−α
17. In Zingara, production per worker can be represented as yt = ktα (At `Y ) , the productivity factor,
η
At , depends on the level of Research and Development; Ȧt = φ Aγt (`A Lt ) . Population Lt grows at a
constant rate n. `Y + `A = 1. Assume that the economy is at its balanced growth path. The effect of
a permanent fall in the fraction of the labor force that works in the R&D sector is
(a) A transitory fall in the level of innovation.
(b) A sudden fall in the growth rate of innovation and a permanent reduction in the level of inno-
vation.
(c) A permanent decrease in the growth rate of innovation.
R At α
18. In Ofir, production per worker can be represented as yt = `1−αYt 0
xjt d j, the level of innovation, At , is
η
given by Ȧt = φ Aγt (`At Lt ) . The production of the intermediate goods xjt needs of capital, xjt ≤ kjt ,
and paying the price of the patent of the idea, Qt . The patent has no time limit. Population Lt grows
at a constant rate n. `Y t + `At = 1. Assume that the economy is at its balanced growth path. In this
economy
(a) The level of innovation is efficient.
(b) The level of innovation is higher than the socially optimal level.
(c) The level of innovation is lower than the socially optimal level.
19. The technological level of Tipoca grows at a constant rate, At = A eg t . The level of adoption in Mos
Espa evolves according to the law ḣt = φ Aγt hθt , and γ + θ < 1. In the long run
(a) Productivity in Mos Espa will grow at a lower rate than productivity in Tipoca.
(b) Mos Espa will grow at a higher rate than productivity in Tipoca.
(c) Productivity in Mos Espa will grow at the same rate than productivity inTipoca.
20. In Nordheim aggregate production can be represented as Yt = Kt0.5 L0.5 t . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. At time t = 0
the stock of capital per worker is k0 = 1. In Aquilonia, the saving rate is s = 0.3. Both economies are
at their steady state. Suppose now that both economies open their capital markets, so that capital can
flow from one country to another one. Then,
(a) The return to capital is the same in both countries and, therefore, it does not move.
(b) Capital flows from Aquilonia to Nordheim.
(c) Capital flows from Nordheim to Aquilonia.
R At α
21. In Turan, production per worker can be represented as yt = `1−α Yt 0
xjt d j, the level of innovation,
η
At , is given by Ȧt = φ Aγt (`At Lt ) . The production of the intermediate goods xjt needs of capital,
xjt ≤ kjt , and paying the price of the patent of the idea, Qt . The patent has no time limit. Population
Lt grows at a constant rate n. `Y t + `At = 1. Assume that the economy is at its balanced growth path.
A new government reduces the life of the patent from infinity to 20 years, time after which anyone can
use the design. Then, in the long run,
(a) The level of innovation stays constant.
(b) The level of innovation increases.
(c) The level of innovation decreases.
22. In Cox the stock of capital is twice the level in Jacarilla. Nevertheless, the return to capital is the same
in both countries. This is because
(a) The level of productivity in Jacarilla is the same that in Cox.
(b) The level of productivity in Jacarilla is higher than in Cox.
(c) The level of productivity in Jacarilla is lower than in Cox.

5
Exercises. Provide clear and concise answers and explain the economic meaning of your results.
23. In Oleza the aggregate production needs of capital and labor according to the production function,
1/3 2/3
Yt = Kt (At Lt ) . Capital depreciates at the rate δ ∈ (0, 1) and the population growth rate is
L̇t
Lt = n ∈ (0, 1). To simplify the calculus, assume that Lt = Nt . The investment rate is s ∈ (0, 1).
The productivity level evolves according to the function Ȧt = n A1−2 t
ψ ψ
Dt , where ψ ∈ (0, 1), and
0 < 1 − 2 ψ < 1. Dt denotes aggregate expenditure in R&D, Dt = d Nt yt , where d ∈ (0, 1). Capital
evolves according to the law K̇t = s Yt − δ Kt . The per capita level of consumption is ct = (1 − s − d)yt .

(a) Obtain the growth rate of output per capita and capital per capita at the balanced growth path.
Proceed as follows:
i. Apply the definition of balanced growth path and write the growth rate of output per capita at
the BGP as a function of the growth rate of the stock of ideas. (2 points)
ii. Now use the law of motion of the stock of ideas, Ȧt = n A1−2
t
ψ ψ
Dt , and find the growth rate
of At at the BGP as a function of parameters. (2 points)
0.5
(b) At the balanced growth path, the stock of knowledge is A∗t = (d Nt yt∗ ) . Find the level of capital,
income and consumption at the BGP. Proceed as follows:
i. Use the production function in per capita terms and write output per capita as a function of
capital and population, Nt (not At ). (2 points)
ii. Now use the law of motion of capital and find the level of capital, income and consumption at
the BGP. (2 points)
(c) Find the optimal rate, d∗ , of expenditures in R&D. (4 points)
(d) In Oleza the rate of expenditures in R&D is below d∗ . Suppose that you can convince the Minister
of Science and Innovation to rise d to the optimal level d∗ . Argue (in words) what will be the effect
on the evolution of consumption in per capital levels, in the short and the long run. (4 points)
24. Consider an economy that produces two goods, an agricultural good and a manufacturing good.
An amount YA t of the agricultural good is produced with land, T , and labor according to Y A t =
θ 1−θ
T (Bt LA t ) . The manufacturing good is produced with the technology YM t = Bt LM t , and LA,t +
LM t = Lt . For simplicity assume that the amount of available land is one, T = 1. Productivity and
population are growing over time, Bt = B eγ t and Lt = L en t .
(a) Assume that the relative price of the agricultural goods (in units of manufacturing goods) is one.
Define `A t = LA t /Lt as the fraction of the labor force working in the agricultural sector.
i. Find the allocation `∗A t that equates the wage across sectors. Remember that the wage, in
equilibrium, must be equal to the marginal productivity of labor. Explain (with words) why the
labor share in the agricultural sector may change (or not) over time. (3 points)
ii. Total GDP is GDPt = YA t + YM t . Show the evolution of GDP over time. (3 points)
iii. Let the price of the land pTt be given by the marginal productivity of land. What happens to
the share of land, pTt T /GDPt ? (3 points)
(b) Assume now that the relative price of agricultural goods (in units of manufacturing goods) is equal
to pA t = φ YYM
At
t
. That is, it varies with the amount produced of each type of good.
i. Find the allocation `∗A t that equates the wage across sectors. Remember that the wage, in
equilibrium, must be equal to the marginal productivity of labor. Explain (with words) why
the labor share in the agricultural sector may change (or not) over time. HINT: You have to
calculate the wage in each sector given the relative price of the agricultural good, pA t , and
substitute the expression of the relative price afterwards. (3 points)
ii. Total GDP is GDPt = pA t YA t + YM t . Show the evolution of GDP over time. (3 points)
iii. Let the price of the land pTt be given by the marginal productivity of land. What happens to
the share of land, pTt T /GDPt ? (3 points)

6
 Economic Growth, year 2015-16
Final exam answer key

Nombre: Versión B
Grupo:

Multiple choice questions (66 points)

1. According to Kaldor
(a) The share of capital income, rt Kt /Yt , has no trend over time.
(b) The share of capital income, rt Kt /Yt , is increasing over time.
(c) The share of capital income, rt Kt /Yt , is decreasing over time.
2. Which of these production functions can represent Gross Domestic Product taking into account the
Kaldor facts and that the capital-labor ratio, Kt /Lt , is increasing over time?
(a) Yt = Kt0.25 L0.75
t + 2 Kt .

−0.5 −2
(b) Yt = 0.3 Kt−0.5 + 0.7 e0.01 t Lt .
(c) Yt = At Kt0.25 L0.65
t .
3. In Genosha, aggregate production can be represented as Yt = Ktα (At ` Nt )1−α . The saving rate is
· ·

s ∈ (0, 1), N At
Nt = n and At = g. ` represents hours worked per capita. Thus, total hours worked are
t

` Nt . At the balanced growth path

(a) Output and capital per capita are constant.
(b) Output and capital per capita grow at the rate g + n.
(c) Output and capital per capita grow at the rate g.
4. in Estigia aggregate production can be represented as Yt = Ktα (At ` Nt )1−α . The saving rate is s ∈
· ·

(0, 1), N At gt
Nt = n and At = A e . ` represents hours worked per capita. A permanent reduction in the
t

population growth produces

(a) A permanent fall in the growth rate of output per capita.
(b) A transitory increase in the growth rate of output per capita.
(c) A transitory fall in the level of output per capita.

1
5. In Oleza aggregate production can be represented as Yt = Kt0.5 L0.5
t . The saving rate is s = 0.2, capital
depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. At time t = 0 the
stock of capital per worker is k0 = 1. Then, over time
(a) Capital, output, and the wage stay constant.
(b) Capital, output, consumption (per worker) and the wage decrease over time. The real return
of capital increases over time.
(c) Capital, output, consumption (per worker) and the wage grow over time. The real return of
capital decreases over time.
6. Consider two economies, Yoknapatawpha and Neopolis. In both the technology to produce final good
0.5
is Yt = Kt0.5 (At Lt ) , where s = 0.2 and δ + n = 0.09. The productivity factor is At = e0.01 t . At
time t = 0 the stock of capital per worker in Yoknapatawpha is half of the stock of capital per worker in
Neopolis.
(a) Both economies will converge to the same balanced growth path.
(b) The growth rate of output per worker is higher in Neopolis than in Yoknapatawpha.
(c) Income per capita in Yoknapatawpha is always half of the income level of the other country.
7. Consider two economies, Tharbad and Bree. The aggregate production in both economies can be
0.5
represented as Yi t = Ki0.5t (Ai Li t ) . The saving rate is, respectively s = 0.2, and s = 0.3, capital
depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. Both economies are
at their steady state and Tharbad level of income per worker is twice that of Bree. This implies that
(a) They have the same level of productivity Ai .
(b) The level of productivity in Tharbad is 3 times the level of productivity in Bree.
(c) The level of productivity in Bree is 3 times the level of productivity in Tharbad.
0.5
8. In Vendhya, aggregate production can be represented as Yt = Kt0.5 (A Lt ) . The saving rate is
s = 0.2, capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01.
Vendhya, at time t = 0, is at its steady state. An earthquake destroys half of the stock of capital of the
economy at t = 1. The effect of the earthquake is
(a) A permanent increase in investment.
(b) A reduction in the return to capital.
(c) A sudden fall in the wage, which recovers over time to its previous level.
0.5
9. In Turan, aggregate production can be represented as Yt = Kt0.5 (At Lt ) . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. The level
of productivity is At = A0 e0.03 t . Turan, at time t = 0, is at its balanced growth path. The government
rises taxes at time t = 1. The effect of such policy is
(a) A permanent reduction in the level of income per worker, a transitory effect on the growth rate
of income per worker.
(b) A permanent reduction in the level of income per worker and the growth rate of income per
worker.
(c) A transitory reduction in the level of income per worker and the growth rate of income per
worker.

2
 α 1−α
10. In Osgiliath, aggregate production can be represented as Y1t = K1t H1t . The saving rate is s ∈ (0, 1),
capital depreciates at the rate δ ∈ (0, 1) and the level of human capital is H1t = eψ1 u1 L1t . The labor
force, Lt grows at the rate n ∈ (0, 1). The government of Osgiliath is worried because their level of
income per worker is lower than that of Tarascón. That is, Y1t /L1t = 0.5 (Y2t /L2t ). Nevertheless, the
capital to output ratio, Kt /Yt , is the same in both countries. So are the saving rate, depreciation of
capital and the population growth rate. Both countries are at their steady state. So the difference must
be due to
(a) The investment rate.
(b) Osgiliath grows at a rate lower than that of Tarascón.
(c) The schooling technology, ψ, is better in Tarascón than in Osgiliath.
11. In Archenland, aggregate production can be represented as Yt = Kt0.5 L0.5 t . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. Archenland,
at time t = 0, is at its steady state. The government liberalizes markets so that the saving rate increases
to s = 0.4. Then:
(a) Consumption falls and increases until it reaches a new higher steady state level.
(b) Consumption increases permanently.
(c) Consumption decreases permanently.
0.5
12. In Doorn, production can be represented as Yt = Kt0.5 (At Lt ) , where the productivity factor depends
on the amount of capital per worker At = A kt , where kt is capital per capita. Population is constant,
Nt = Lt = 1. The saving rate is s = 0.3, capital depreciates at the rate δ ∈ (0, 1), and s A > δ. The
growth rate of income per worker at the balanced growth path is
(a) n.
(b) s A − δ.
(c) s − δ.
0.5
13. In Atlantida, production can be represented as Yt = Kt0.5 (At Lt ) , where the productivity factor de-
pends on the amount of capital per worker At = kt , where kt is capital per capita. Population is
constant, Nt = Lt = 1. The saving rate is s = 0.3, capital depreciates at the rate δ = 0.1. The
government imposes a tax rate τ = 0.1 over income. The change in the growth rate of income at the
balanced growth path is
(a) 0.03.
(b) −0.03.
(c) 0.17.
0.5
14. In Corinthia, production per worker can be represented as yt = kt0.5 (At Lt ) , where the productivity
factor depends on the amount of capital per worker At = kt . Population is constant. The saving rate
is s = 0.3, capital depreciates at the rate δ = 0.1. An earthquake destroys half of the stock of capital
of the economy at t = 1. The effect of the earthquake is
(a) A permanent increase in investment.
(b) A transitory increase in the growth rate of income, leaving its long run level unaffected.
(c) A permanent reduction in the level of income, leaving its growth rate unaffected.

3
  0.2
T
15. In Barataria, production per worker can be represented as At kt0.5 Nt `0.3 , the productivity factor,
At , grows at the rate γ ∈ (0.1). The saving rate is s = 0.3, capital depreciates at the rate δ = 0.1.
The workforce grows at the rate n = 0.01. For the growth rate of income per capita in Barataria to be
positive in the long run, the growth rate of productivity, γ should be higher than
(a) 2%.
(b) 1%.
(c) 0%.
16. In Aquilonia, production per worker can be represented as yt = At ktα mθt `1−α−θ , the productivity factor,
At , grows at the rate γ ∈ (0.1). The amount of energy used (in per capita terms), mt , is a constant
fraction of the stock of oil, mt =  ρt , where the evolution of the stock in per capita terms is ρt =
ρ0 e−(+n)t . The stock of oil is owned by the State of Aquilonia. The extraction rate is . The government
of Aquilonia wants to double the extraction rate. The effect is going to be
(a) An increase in the growth rate of income in the short and the long run.
(b) An increase in the level of income per capita in the short run, a lower growth rate of income
per capita in the long run.
(c) An increase in the level of income per capita in the long run, a lower growth rate of income per
capita in the short run.
1−α
17. In Zingara, production per worker can be represented as yt = ktα (At `Y ) , the productivity factor,
η
At , depends on the level of Research and Development; Ȧt = φ Aγt (`A Lt ) . Population Lt grows at a
constant rate n. `Y + `A = 1. Assume that the economy is at its balanced growth path. The effect of
a permanent fall in the fraction of the labor force that works in the R&D sector is
(a) A transitory fall in the level of innovation.
(b) A sudden fall in the growth rate of innovation and a permanent reduction in the level of inno-
vation.
(c) A permanent decrease in the growth rate of innovation.
R At α
18. In Ofir, production per worker can be represented as yt = `1−αYt 0
xjt d j, the level of innovation, At , is
η
given by Ȧt = φ Aγt (`At Lt ) . The production of the intermediate goods xjt needs of capital, xjt ≤ kjt ,
and paying the price of the patent of the idea, Qt . The patent has no time limit. Population Lt grows
at a constant rate n. `Y t + `At = 1. Assume that the economy is at its balanced growth path. In this
economy
(a) The level of innovation is efficient.
(b) The level of innovation is higher than the socially optimal level.
(c) The level of innovation is lower than the socially optimal level.
19. The technological level of Tipoca grows at a constant rate, At = A eg t . The level of adoption in Mos
Espa evolves according to the law ḣt = φ Aγt hθt , and γ + θ < 1. In the long run
(a) Productivity in Mos Espa will grow at a lower rate than productivity in Tipoca.
(b) Mos Espa will grow at a higher rate than productivity in Tipoca.
(c) Productivity in Mos Espa will grow at the same rate than productivity inTipoca.

4
 20. In Nordheim aggregate production can be represented as Yt = Kt0.5 L0.5 t . The saving rate is s = 0.2,
capital depreciates at the rate δ = 0.09 and the labor force, Lt grows at the rate n = 0.01. At time t = 0
the stock of capital per worker is k0 = 1. In Aquilonia, the saving rate is s = 0.3. Both economies are
at their steady state. Suppose now that both economies open their capital markets, so that capital can
flow from one country to another one. Then,
(a) The return to capital is the same in both countries and, therefore, it does not move.
(b) Capital flows from Aquilonia to Nordheim.
(c) Capital flows from Nordheim to Aquilonia.
R At α
21. In Turan, production per worker can be represented as yt = `1−α Yt 0
xjt d j, the level of innovation,
γ η
At , is given by Ȧt = φ At (`At Lt ) . The production of the intermediate goods xjt needs of capital,
xjt ≤ kjt , and paying the price of the patent of the idea, Qt . The patent has no time limit. Population
Lt grows at a constant rate n. `Y t + `At = 1. Assume that the economy is at its balanced growth path.
A new government reduces the life of the patent from infinity to 20 years, time after which anyone can
use the design. Then, in the long run,
(a) The level of innovation stays constant.
(b) The level of innovation increases.
(c) The level of innovation decreases.
22. In Cox the stock of capital is twice the level in Jacarilla. Nevertheless, the return to capital is the same
in both countries. This is because
(a) The level of productivity in Jacarilla is the same that in Cox.
(b) The level of productivity in Jacarilla is higher than in Cox.
(c) The level of productivity in Jacarilla is lower than in Cox.

Exercises. Provide clear and concise answers and explain the economic meaning of your results.
23. In Oleza the aggregate production needs of capital and labor according to the production function,
1/3 2/3
Yt = Kt (At Lt ) . Capital depreciates at the rate δ ∈ (0, 1) and the population growth rate is
L̇t
Lt = n ∈ (0, 1). To simplify the calculus, assume that Lt = Nt . The investment rate is s ∈ (0, 1).
The productivity level evolves according to the function Ȧt = n A1−2 t
ψ ψ
Dt , where ψ ∈ (0, 1), and
0 < 1 − 2 ψ < 1. Dt denotes aggregate expenditure in R&D, Dt = d Nt yt , where d ∈ (0, 1). Capital
evolves according to the law K̇t = s Yt − δ Kt . The per capita level of consumption is ct = (1 − s − d)yt .
(a) Obtain the growth rate of output per capita and capital per capita at the balanced growth path.
Proceed as follows:
i. Apply the definition of balanced growth path and write the growth rate of output per capita at
the BGP as a function of the growth rate of the stock of ideas. (2 points)
1/3 2/3
Answer: The production function in per capita terms is yt = kt At . Thus, taking logs and
differentiating with respect to time, ẏytt = 13 k̇ktt + 23 A
Ȧt
t
. At the balanced growth path (BGP
ẏ ∗ k̇∗ Ȧ∗
hereafter), output and capital should grow at the same rate. Thus, yt∗ = kt∗ = At∗ = g,
t t t
where g is still unknown.
ii. Now use the law of motion of the stock of ideas, Ȧt = n A1−2
t
ψ ψ
Dt , and find the growth rate
of At at the BGP as a function of parameters. (2 points)
Ȧ∗ −2 ψ ψ
Answer: The growth rate of ideas of ideas in the BGP is A∗
t
= n (A∗t ) (d Nt yt∗ ) , which
t
−2 ψ ψ
is g = n (A∗t ) (d Nt yt∗ ) . taking logs and differentiating wth respect to time, 0 =
Ȧ∗ ẏt∗
−2 ψ A∗+ ψ n + ψ . Since the growth rate of innovation and output per capita are equal
t
yt∗
t
at the BGP, it follows that g = n.

5
 0.5
(b) At the balanced growth path, the stock of knowledge is A∗t = (d Nt yt∗ ) . Find the level of capital,
income and consumption at the BGP. Proceed as follows:
i. Use the production function in per capita terms and write output per capita as a function of
capital and population, Nt (not At ). (2 points)
0.5
Answer: You can check that, indeed, at the BGP A∗t = (d Nt yt∗ ) . Now substitute this ex-
pression in the production function (I am omitting the ∗ to not clutter the writing), yt =
 2/3
1/3 2/3 1/3 0.5 1/3 1/3 2/3
k t At = kt (d Nt yt∗ ) , hence yt = kt ((d Nt yt∗ )) , simplifying, yt =
1/3 1/3 0.5
kt (d Nt ) , hence yt = kt0.5 (d Nt ) .
ii. Now use the law of motion of capital and find the level of capital, income and consumption at
the BGP. (2 points)
Answer: The law of motion of capital, in per capita terms, is k˙t = s yt −(δ+n)kt . Substituting,
0.5
k̇t = s kt0.5 (d Nt ) − (δ + n)kt . At the BGP, k̇t = g kt . Recall, g = n. Thus, at the BGP,
 2  
0.5
n kt = s kt0.5 (d Nt ) − (δ + n)kt . Thus, kt∗ = delta+2 s
n d Nt , yt
∗
= s
delta+2 n d Nt ,
 
and c∗t = (1 − s − d) δ+2 n d Nt .
s

(c) Find the optimal rate, d∗ , of expenditures in R&D. (4 points)

Answer: Maximizing c∗t with respect to d amounts to maximizing (1 − s − d)d. Hence, d∗ = 1−s 2 .
That is, Oleza should invest in R&D activities the fraction 1−s2 of its total GDP.
(d) In Oleza the rate of expenditures in R&D is below d∗ . Suppose that you can convince the Minister
of Science and Innovation to rise d to the optimal level d∗ . Argue (in words) what will be the effect
on the evolution of consumption in per capital levels, in the short and the long run. (4 points)
Answer: We could think of d∗ as a golden rule for investment in R&D. If we increase our expen-
ditures in R&D to d∗ , the effect of this policy on consumption should qualitatively the same
that the effect of increasing the saving rate to the golden rule. In the short run, consumption
falls and it rises to a new balanced growth path with a higher level of consumption.
24. Consider an economy that produces two goods, an agricultural good and a manufacturing good.
An amount YA t of the agricultural good is produced with land, T , and labor according to Y A t =
θ 1−θ
T (Bt LA t ) . The manufacturing good is produced with the technology YM t = Bt LM t , and LA,t +
LM t = Lt . For simplicity assume that the amount of available land is one, T = 1. Productivity and
population are growing over time, Bt = B eγ t and Lt = L en t .
(a) Assume that the relative price of the agricultural goods (in units of manufacturing goods) is one.
Define `A t = LA t /Lt as the fraction of the labor force working in the agricultural sector.
i. Find the allocation `∗A t that equates the wage across sectors. Remember that the wage, in
equilibrium, must be equal to the marginal productivity of labor. Explain (with words) why the
labor share in the agricultural sector may change (or not) over time. (3 points)
Answer: Since labor is mobile across sectors, the wage must be equal in both sectors. In an
competitive economy, the wage equals the marginal productivity of labor. Thus, Bt = (1−
(1−θ)f rac1θ
Bt−1
θ)Bt1−θ L−θ
At . Hence, LAt = (1 − θ)
f rac1θ −1
Bt and, therefore, `At ≡ LAt
Lt = Lt .
(1−θ)f rac1θ −(γ+n)t
Given the expressions of Bt and Lt , we can write `At = BL e . Hence, the
absolute level of workers in the agricultural sector falls because productivity in the agri-
cultural sector grows at the rate θ gamma, whereas productivity in manufacturing grows
at the rate γ. That is, if the employment size of both sectors were equal, the wage of man-
ufacturing would rise faster than the wage in the agricultural sector. Hence, employment
in the agricultural sector must fall over time.
ii. Total GDP is GDPt = YA t + YM t . Show the evolution of GDP over time. (3 points)

1−θ
Answer: YAt = Bt (1 − θ)f rac1θ Bt−1 , hence YAt = (1 − θ)f rac1−θθ . Since LM t = Lt −
1 1
LAt , then YM t = Bt Lt − (1 − θ) θ . Thus, adding up, GDPt = Bt Lt − (1 − θ) θ + (1 −
θ)f rac1−θθ . Simplifying, GDPt = Bt Lt + (1 − θ)f rac1θ . It increases over time, at a lower
rate than output in the manufacturing sector.

6
 iii. Let the price of the land pTt be given by the marginal productivity of land. What happens to
the share of land, pTt T /GDPt ? (3 points)
θ−1 1−θ
Answer: The price of land must be equal to its marginal productivity, pTt = θ T (Bt LA t ) .
pT
T YAt
Hence, pTtT = θ YAt . Thus, t
GDPt =θ GDPt .This share is decreasing over time, since
output of the agricultural sector, as a fraction of GDP, falls over time.
(b) Assume now that the relative price of agricultural goods (in units of manufacturing goods) is equal
to pA t = φ YYM
At
t
. That is, it varies with the amount produced of each type of good.
i. Find the allocation `∗A t that equates the wage across sectors. Remember that the wage, in
equilibrium, must be equal to the marginal productivity of labor. Explain (with words) why
the labor share in the agricultural sector may change (or not) over time. HINT: You have to
calculate the wage in each sector given the relative price of the agricultural good, pA t , and
substitute the expression of the relative price afterwards. (3 points)
Answer: The wage must be equal across sectors. Thus, wt = ∂ YM t /∂ LM t and wt =
∂ pAt YAt /∂ LAt . Hence, wt = Bt and wt = pAt (1 − θ)Bt1−θ L−θ At . Marginal productivity of
YAt
labor in the agricultural sector can be written as wt = pAt (1 − θ) L At
. Taking into account
YM t
that pA t = φ YA t , and substituting in the expression for the marginal productivity of labor
in the agricultural sector, wt = φ(1 − θ) YLM t
At
. Thus, equating the wage across sectors,
φ(1−θ)
Bt = (1 − θ) YLM t
At
. Since YM t = Bt LM t , then 1 = φ(1 − θ) LLM t
At
, and LAt /Lt = 1+φ(1−θ) .
Thus, the share of labor in the agricultural sector is constant over time. This is so because
the relative price of agricultural goods is rising over time.
ii. Total GDP is GDPt = pA t YA t + YM t . Show the evolution of GDP over time. (3 points)
Answer: Notice that substituting the expression for the relative price of agricultural goods,
Bt Lt
GDPt = (1 + φ)YM t , thus, GDP = 1+φ(1−θ) . GDP grows at the same rate that output in
the manufacturing sector.
iii. Let the price of the land pTt be given by the marginal productivity of land. What happens to
the share of land, pTt T /GDPt ? (3 points)
θ−1 1−θ
Answer: The price of land must be equal to its marginal productivity, pTt = pAt θ T (Bt LA t ) .
pT T θ
Hence, pTt T = pAt θ YAt = θ YM t . Thus, GDPt = 1+φ
t
. This share is constant over time,
since output of the agricultural sector, as a fraction of GDP, is constant over time.