Problem Set 3

FE312 Fall 2011

Rahman

Some Answers

1) Assume that production is a function of capital and labor, and that the rate of savings
and depreciation are constant, as described in Chapter 7’s version of the Solow Model.
Further, assume that the production function can be described by the function:

1 1
   
YK 2
L2

where K is capital and L is labor.

a. What is the per-worker production function y=f(k)? Show your work.

1 1 1 1 1

          1
Y K  2  L 2  K  2  L 2  K  2   
  1 1  1  k2
L L  
2
 
2
 
2
L L L

b. Solve for steady-state capital per worker, production per worker, and consumption
per worker with s = 0.4 ? (Note: you need to set Δk = 0, to get an equation in s, δ,
and k, and then solve for k).

2
s
When k is in steady-state, sk *0.5  k * This gives us k *    , which means that
 
s 0.4
y*     . Consumption per worker in steady-state then is just
  
s 0.24
c*  (1  s )   .
  

1 1
   
2) Assume once again that production is given by: Y  K L . First, write the
2 2

production function in per person terms (y=f(k)). Next, assume that the per person level
of capital in the steady state is 4, the depreciation rate is 5% per year, and population
growth is 5% per year. Does this economy have “too much” or “too little” capital? How
do you know? [Show your work].

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 Problem Set 3
FE312 Fall 2011
Rahman

Recall that when the economy is at the golden rule steady-state, MPK *   .  n
Given that f (k )  k 1 / 2 , this means that (1 / 2) * k G .R. *1 / 2    n. Using the
numbers given to us above, our solution gives us k G .R. *  25 . Given that our
steady state capital stock is at 4, it means that we have WAY too little capital (at
least compared with the golden rule level).

3) Suppose that two countries are exactly alike in every respect (meaning they have the
same levels of capital, output, depreciation, etc.) except that the citizens of country A
have a higher saving rate than the citizens of country B.

a. Which country will have the higher level of output per worker in the steady state?
Illustrate graphically.

b. Which country will have the faster rate of growth of output per worker?

output

depreciation line
investment
yA= yB (country A)

investment
(country B)

kA= kB capital per worker

While each country starts with the same amount of capital per worker (and
therefore starts with the same output per worker), we can see that country A has the
higher steady state. Notice also that at this initial position, k A  k B . Therefore
country A will grow faster as well.

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 Problem Set 3
FE312 Fall 2011
Rahman

4) Suppose that two countries are exactly alike in every respect (meaning they have the
same levels of capital, output, depreciation, etc.) except that population grows at a faster
rate in country A than in country B.

a. Which country will have the higher level of output per worker in the steady state?
Illustrate graphically.

b. Which country will have the faster rate of growth of output per worker?

output

depreciation line
(country A)
depreciation line
yA= yB
(country B)
investment

kA= kB capital per worker

While each country starts with the same amount of capital per worker (and
therefore starts with the same output per worker), we can see that country B has the
higher steady state. Notice also that at this initial position, k B  k A . Therefore
country B will grow faster as well.

5) The initial steady-state level of capital per worker in Macroland is 5. The Golden
Rule level of capital per worker in Macroland is 8.

a. What must change in Macroland to achieve the Golden Rule steady state?

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 Problem Set 3
FE312 Fall 2011
Rahman
Macroland clearly needs more capital per person. It can get this by increasing its
rate of savings.

b. Why might the Golden Rule steady state be preferred to the initial steady state? (two
or three sentences)

Golden rule means that long run consumption is maximized. Since conceivably
we care not only about our consumption, but also the consumption of our
children, their children, and so on, that seems like a good thing.

c. Why might some current workers in Macroland prefer the initial steady state to the
Golden Rule steady state? (two or three sentences)

In order to get to the golden rule, we will have to cut our consumption levels
NOW. Some workers might view the short-run costs as bigger than the long-run
gains, and therefore opt not to increase savings.

By the way, another approach to get closer to the golden rule would be to lower
population growth (provided n > 0). To the extent that society can effectively influence
rates of growth in population, what are the costs and benefits of doing so? Think about
it.

6) The economy of Alpha can be described by the Solow growth model. The following
are some characteristics of the Alpha economy:

savings rate (s) 0.20

depreciation rate (δ) 0.12
steady-state capital per worker (k*) 4
population growth rate (n) 0.02
steady-state output per worker 20,000

a. What is the steady-state growth rate of output per worker in Alpha?

In the steady state, capital per worker is constant, so output per worker is
constant. Thus, the growth rate of steady-state output per worker is 0.

b. What is the steady-state growth rate of total output in Alpha?

In the steady state, population grows at 2 percent (0.02). Capital must grow at a
rate of 2 percent in order to maintain a constant capital per worker ratio in the
steady state; therefore, given the constant returns to scale production function,
total output must increase at a 2 percent rate.

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 Problem Set 3
FE312 Fall 2011
Rahman

c. What is the level of steady-state consumption per worker in Alpha?

If the saving rate is 20 percent, then the consumption rate is 80 percent. Steady-
state consumption per worker is 16,000.

d. What is the steady-state level of investment per worker in Alpha?

4,000.

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