4,212,2 Macroeconomics III

Take-Home Exercise 3

deadline: CET 12:00 pm (noon) on Tuesday, March 28th, 2023

1. Please work in groups of maximum 3 on the exercises. Only one team

member has to upload the solutions using the file naming convention:
lastname1 lastname2 lastname3.filetype. Make sure you submit the
homework as a group and not as an individual, using the preset groups.
2. Please upload your answers using the “Assignments” folder for the
relevant take-home exercise on the StudyNet (Canvas) page of the
lecture (4,212,2.00).
3. You are responsible for verifying that you can upload files to the
required folder prior to the deadline. Unfortunately no extensions
will be given.
4. As long as all submitted work is legible, files can be submitted using
any standard file format: (.pdf, .jpeg, .xls, etc.). However, all results
should be made available to the reader without having to run codes
(e.g. if you have a Matlab/R code, submit your output in an additional
file). You may submit multiple files for one exercise.
5. If you upload multiple files, archive them in a zip-file and name it
according to the rule in 1. Clearly indicate the names and student
numbers on all files that you submit.

GOOD LUCK!

Exercise 3.1
This is a simulation exercise related to the Solow model with human capital.
Assume the following parameters for this economy: α = 61 and φ = 16 , sK =
0.20, sH = 0.20, n = 0.01, g = 0.02 and δ = 0.10 and initialize technology
as A0 = 1. Assume that this economy starts on the balanced growth path
in period 0. Also, the government considers permanently increasing either
sH or sK from period 20.

1
a) Show that, given the values of the model’s other parameters, the sizes of
the investment rates, sK and sH , that will maximize the altitude of the
growth path of consumption per worker in the steady state of the Solow
model with human capital are sK = α and sH = φ.

b) Use the phase diagram to qualitatively describe the effects of an increase

in sK (i.e. draw a phase diagram and show what happens if sK increases).
Do the same for an increase in sH .

c) Suppose the government decides to increase sK to 0.30 in period 20. Sim-

ulate this economy (Economy 1), i.e. produce time series for k̃t , h̃t , ỹt ,
c̃t , sK ỹt (i.e. investment into physical capital), sH ỹt (i.e. investment into
human capital), At , ln(yt ), ln(ct ), and gty = ln(yt ) − ln(yt−1 ). Simulate
200 periods.

d) Now suppose that instead of changing sK , the government decides to

increase sH to 0.30 in period 20. Simulate this economy (Economy 2),
creating the same time series as in b).

e) Produce diagrams showing the evolution of the following variables:

• Diagram 1: k̃t
• Diagram 2: h̃t
• Diagram 3: ỹt
• Diagram 4: c̃t
• Diagram 5: ln(yt )
• Diagram 6: ln(ct )
• Diagram 7: gty

In each of the diagrams, show the evolution for both economies. Interpret
your results.

f) How do your findings change if we assume α = φ = 1/3, which is a more

plausible calibration given the empirical evidence?

Exercise 3.2
This is an analytical question based on the Solow model with oil. Consider
the following aggregate production function, taken from section 7.2 in the
textbook,

Yt = Ktα (At Lt )β (sE Rt ) , (1)

with α+β + = 1. sE Rt = Et is energy and Rt+1 = Rt −Et (i.e. gtR = −sE ).

2
a) Take the first order conditions with respect to the three production fac-
∂Yt ∂Yt
tors and derive the factor rewards i.e. find rt = ∂K t
, wt = ∂Lt
, and

ut = ∂(s∂Y t
E Rt )
.

rt Kt wt Lt ut (sE Rt )
b) Find the income shares Yt , Yt , and Yt and show that they are
constant.

c) Write down the production function in per capita units and show that
the (approximate) growth rate of yt on the balanced growth path (i.e.
where yt and kt grow at the same rate) equals

β A  
gy = g − n− sE (2)
β+ β+ β+
Hint: use α + β +  = 1.

d) Using equation (2) and your solutions to b), show that the growth rate of
rt is zero and that wages grow at a constant rate on the balanced growth
path. Furthermore, find the growth rate of ut on the BGP. How does ut
evolve compared to wt ?