TSHWANE UNIVERSITY OF TECHNOLOGY

FACULTY OF ECONOMICS AND FINANCE

DEPARTMENT OF ECONOMICS

2023 SUMMATIVE ASSESSMENT

SUBJECT: INTERMEDIATE MACROECONOMICS
SUBJECT CODE: IMA107V
TIME ALLOWED: 2hr.
Date: 23 AUGUST 2023
TOTAL MARKS: 100

SPECIAL REQUIREMENTS: CALCULATORS

INSTRUCTIONS TO CANDIDATES: ANSWER ALL THE QUESTIONS
NUMBER OF PAGES:
NUMBER OF ANNEXURES: none

COURSES: COORDINATOR:
ADVANCED DIPLOMA IN ECONOMICS DR MC NYATHI

MODERATOR:
PROF B SIMO-KENGNE

INSTRUCTIONS: ANSWER ON THE ANSWER SHEET PROVIDED

SECTION A (40 MARKS)

1. Name THREE disadvantages of the Solow Growth model, in accordance with the
Overlapping Generations Model (9 Marks).

Answers

- The saving decision on the part of the representa�ve household is exogenously given and
not derived from an underlying economic decision-making problem [3].
- Without a descrip�on of preferences, it is difficult to say much about norma�ve
implica�ons of the model as they relate to policy [3].
- Because the model is populated by one representa�ve household that lives forever, it is
not possible to address issues related to intergenera�onal transfers [3].

2. Explain the conditions for an Agent to be regarded as OPTIMISING (3 Marks).

Answer

- At an optimum, the marginal utility benefit must equal the marginal utility cost [3].

3. Explain what is meant by saying an Agent in NOT OPTIMISING (3 Marks).

Answer

- Where the marginal utility benefit of saving exceeded the cost, the household should be
saving more, and hence could not be optimizing [3].

4. Assume that the size of the young population evolves exogenously according to: 𝑁𝑁𝑡𝑡 =
(1 + 𝑛𝑛)𝑁𝑁𝑡𝑡−1, where 𝑛𝑛 > 0. How does this equation change if 𝑛𝑛 = 0, and what would it
mean (9 Marks)
Answer

𝑁𝑁𝑡𝑡 = (1 + 𝑛𝑛)𝑁𝑁𝑡𝑡−1

→ 𝑁𝑁𝑡𝑡 = (1 + 0)𝑁𝑁𝑡𝑡−1

→ 𝑁𝑁𝑡𝑡 = (1)𝑁𝑁𝑡𝑡−1

→ 𝑁𝑁𝑡𝑡 = 𝑁𝑁𝑡𝑡−1

[5 Marks]

n = 0 would mean that the same number of households are born each period as die, so that the
total population is constant [4 Marks].

5. Illustrate and explain quantitative convergence in the Overlapping Generations Model (16
Marks).

Answer

[10 Marks]
- We can observe that if the economy starts in a steady state, it stays there [3 Marks].
- If it starts above, it converges down to the steady state, and similarly from below [3
Marks].
SECTION B (60 MARKS)
Consider the following overlapping generations model where there are two types of agents alive
- young and old. Each household lives for two periods.

The total number of agents alive in any period is 𝑁𝑁𝑁𝑁 + 𝑁𝑁𝑁𝑁 − 1, where 𝑁𝑁𝑁𝑁 − 1 and 𝑁𝑁𝑁𝑁 denotes
the number of old and young households alive in t.

Lifetime utility is given by:

𝑼𝑼 = 𝒖𝒖�𝒄𝒄𝒚𝒚;𝒕𝒕 � + 𝜷𝜷𝜷𝜷(𝒄𝒄𝟎𝟎;𝒕𝒕+𝟏𝟏 ) (1)

Subject to the following constraints:
𝒄𝒄𝒚𝒚;𝒕𝒕 + 𝒔𝒔𝒕𝒕 ≤ 𝒘𝒘𝒕𝒕 (2)
And
𝒄𝒄𝟎𝟎;𝒕𝒕+𝟏𝟏 ≤ [𝑹𝑹𝒕𝒕+𝟏𝟏 + (𝟏𝟏 − 𝜹𝜹)] 𝒔𝒔𝒕𝒕 (3)

1. Use the information given above to characterize and solve the Households optimisation
problem (15 Marks).
Solutions:
𝑀𝑀𝑀𝑀𝑀𝑀
𝑈𝑈 = 𝑢𝑢(𝑤𝑤𝑡𝑡 − 𝑠𝑠𝑡𝑡 ) + 𝛽𝛽𝛽𝛽([𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)]𝑠𝑠𝑡𝑡 ) [3 Marks]
𝑠𝑠𝑡𝑡

→ 𝑢𝑢′ (𝑤𝑤𝑡𝑡 − 𝑠𝑠𝑡𝑡 )(−1) + 𝛽𝛽(𝑢𝑢([𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)]𝑠𝑠𝑡𝑡 )′ + 𝛽𝛽 ′ 𝑢𝑢([𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)]𝑠𝑠𝑡𝑡 ) [3 Marks]

𝜕𝜕𝜕𝜕
𝜕𝜕𝑠𝑠𝑡𝑡
= 0 → −𝑢𝑢′ (𝑤𝑤𝑡𝑡 − 𝑠𝑠𝑡𝑡 ) + 𝛽𝛽[𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)]𝑢𝑢′ ([𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)𝑠𝑠𝑡𝑡 ]) [3 Marks]

→ 𝑢𝑢′ (𝑤𝑤𝑡𝑡 − 𝑠𝑠𝑡𝑡 ) = 𝛽𝛽[𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)]𝑢𝑢′ ([𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)𝑠𝑠𝑡𝑡 ]) [3 Marks]

𝑢𝑢′ �𝑐𝑐𝑦𝑦;𝑡𝑡 � = 𝛽𝛽[𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)] 𝑢𝑢′ (𝑐𝑐0;𝑡𝑡+1 ) [3 marks]

 2. Give an intuitive meaning of the arguments in the last step of the above optimisation
problem (6 Marks).
Solutions:

𝑢𝑢′ �𝑐𝑐𝑦𝑦;𝑡𝑡 � - the left-hand side of the last step may be interpreted as the marginal utility cost of
saving more in youth period [3].
𝛽𝛽[𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)] 𝑢𝑢′ (𝑐𝑐0;𝑡𝑡+1 )- the right-hand side represents the marginal utility benefit of
saving more in youth [3].

3. Using the above information, if we now assume that the flow utility function of household
is a natural log, i.e., 𝑢𝑢(. ) = 𝑙𝑙𝑙𝑙(. ). With this specification of preferences, derive the
savings function equation (15 Marks).
Solutions:
𝜕𝜕𝜕𝜕
= 0 → −𝑢𝑢′ (𝑤𝑤𝑡𝑡 − 𝑠𝑠𝑡𝑡 ) + 𝛽𝛽[𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)]𝑢𝑢′ ([𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)𝑠𝑠𝑡𝑡 ])
𝜕𝜕𝑠𝑠𝑡𝑡
→ 𝑢𝑢′ (𝑤𝑤𝑡𝑡 − 𝑠𝑠𝑡𝑡 ) = 𝛽𝛽[𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)]𝑢𝑢′ ([𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)𝑠𝑠𝑡𝑡 ])
1 1
→ 𝑤𝑤 −𝑠𝑠 = 𝛽𝛽[𝑅𝑅𝑡𝑡+1 + (1 − 𝛿𝛿)] [𝑅𝑅 [2]
𝑡𝑡 𝑡𝑡 𝑡𝑡+1 +(1−𝛿𝛿)]𝑠𝑠𝑡𝑡 ]

1 𝛽𝛽
→ 𝑤𝑤 −𝑠𝑠 = 𝑠𝑠 [3]
𝑡𝑡 𝑡𝑡 𝑡𝑡

→ 𝑠𝑠𝑡𝑡 = 𝛽𝛽(𝑤𝑤𝑡𝑡 − 𝑠𝑠𝑡𝑡 ) [2]

→ 𝑠𝑠𝑡𝑡 = 𝛽𝛽𝑤𝑤𝑡𝑡 − 𝛽𝛽𝑠𝑠𝑡𝑡 [2]
→ 𝑠𝑠𝑡𝑡 + 𝛽𝛽𝑠𝑠𝑡𝑡 = 𝛽𝛽𝑤𝑤𝑡𝑡 [2]
→ 𝑠𝑠𝑡𝑡 (1 + 𝛽𝛽) = 𝛽𝛽𝑤𝑤𝑡𝑡 [2]
𝛽𝛽
→ 𝑠𝑠𝑡𝑡 = (1+𝛽𝛽) 𝑤𝑤𝑡𝑡 [2]

NB: any method used to get to the final step should be awarded marks.
 4. If the firm’s production function is Cobb-Douglas e.g., 𝐹𝐹(𝐾𝐾𝑡𝑡 , 𝑁𝑁𝑡𝑡 ) = 𝐾𝐾𝑡𝑡𝛼𝛼 , 𝑁𝑁𝑡𝑡1−𝛼𝛼 with 0 <
𝛼𝛼 < 1. Using the logarithmic specification of preferences, derive the central equation of
the overlapping generations model (24 Marks).
Solutions:

𝐹𝐹(𝐾𝐾𝑡𝑡 , 𝑁𝑁𝑡𝑡 ) = 𝐾𝐾𝑡𝑡𝛼𝛼 , 𝑁𝑁𝑡𝑡1−𝛼𝛼

𝑤𝑤𝑡𝑡 = (1 − 𝛼𝛼)𝐴𝐴𝐾𝐾𝑡𝑡𝛼𝛼 , 𝑁𝑁𝑡𝑡−𝛼𝛼 [3]
𝑤𝑤𝑡𝑡 = (1 − 𝛼𝛼)𝐴𝐴𝐴𝐴𝑡𝑡𝛼𝛼 [3]
𝛽𝛽
𝑠𝑠𝑡𝑡 = 𝑤𝑤
(1 + 𝛽𝛽) 𝑡𝑡
𝑁𝑁𝑡𝑡 = (1 + 𝑛𝑛)𝑁𝑁𝑡𝑡−1
𝑁𝑁𝑡𝑡+1 = (1 + 𝑛𝑛)𝑁𝑁𝑡𝑡 [3]

𝐾𝐾𝑡𝑡+1 = 𝑁𝑁𝑡𝑡 𝑠𝑠𝑡𝑡

𝐾𝐾𝑡𝑡+1 𝑁𝑁 𝑠𝑠
= 𝑁𝑁 𝑡𝑡 𝑡𝑡 [3]
𝑁𝑁𝑡𝑡+1 𝑡𝑡+1

𝑁𝑁 𝑠𝑠
𝑡𝑡 𝑡𝑡
𝑘𝑘𝑡𝑡+1 = (1+𝑛𝑛)𝑁𝑁 [3]
𝑡𝑡

𝑠𝑠𝑡𝑡
𝑘𝑘𝑡𝑡+1 =
1 + 𝑛𝑛
𝛽𝛽
�(1+𝛽𝛽)𝑤𝑤𝑡𝑡 �
𝑘𝑘𝑡𝑡+1 = 1+𝑛𝑛
[3]
𝛽𝛽
((1+𝛽𝛽)((1−𝛼𝛼)𝐴𝐴𝐴𝐴𝑡𝑡𝛼𝛼 ))
𝑘𝑘𝑡𝑡+1 = 1+𝑛𝑛
[3]

𝛽𝛽(1−𝛼𝛼)𝐴𝐴𝐴𝐴 𝛼𝛼
𝑡𝑡
𝑘𝑘𝑡𝑡+1 = (1+𝛽𝛽)(1+𝑛𝑛) [3]