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2012 Macro Qualifier (June)
Instructions: There are two parts. They are equally weighted. Follow the in-
structions given for each part. You have 4 hours.
Part 1
1. Consider the following growth model where the planner chooses sequences of consump-
tion in order to
max > Bt log(ce),
=
Ste Cet hess S Ae(he)®,t 2 0,
ky > 0.
Suppose that the sequence {Ay;t > 0} follows a periodic pattern, that is, Ar = 1 for
$=0,2,4,... and Ay =A > 1 for t= 1,3,5,...
(2) Set up the Bellman functional equations associated with odd period and even
period.
(b) Solve for the policy functions applicable to odd periods and policy functions =p-
plicable to even periods. (Conjecture that the value function takes the form of
a, + be log(k) in even periods and a, +0, log(k) in odd periods, where ae, be, do, bo
are parameters)
(c) Show that the “steady state” of this dynamic model contains a two-period cycle.
2, Consider an economy with a continuum of identical consumers. The utility of a repre-
sentative consumer is a
E [= oe ,
=
where f € (0,1), ¢ is consumption and E is the expectation operator. Bach consumer
owns 2 trees, indexed by g and b. The fruit of tree i € {9,0}, yi, evolves as
where 6; is an aggregate shock whose value is either MT or L. 0 0. C is a consumption index given by
“(fowl
with C (j) representing the quantity of good i consumed by the household, I assume
the existence of a continuum of goods represented by [0, N] interval. ¢ is greater than
1. H hours of time are inelastically supplied for work (in ather words, H is fixed, not
a choice variable). ‘The budget constraint is
nN
[ PC) di =WH+T
5
where W is the nominal wage and T is a lump-sum component of income, or more
specifically, T is the dividend income (the houschold is the owner of the firms). Since
the right-hand side of the budget constraint is exogenous to the household, the remain-
ing problem is finding the optimal allocation of consumption expenditure, which we
will solve below.
(a) The problem of maximizing C given
:
i P()CWdi=WH+T (a
Is
can be expressed by moans of the Lagrangean
N ae rd N
L= [[ cw? a] fy [f POCwa-wa-T|
bo :
Derive the associated first-order conditions
Pa) _ ( 218)
PG) \C().
for any i,j € (0, N).
(b) The first order condition can be written as
ew= ow (FO) ®
Show that substituting (2) into (1) obtains
aoe for tea Pa
cy) (si) [ Pdi WHT @)
3 (c) Define P = [ Je Pw" ai] F= Show that (3) can be written os
avn fr “WH+T
ow= (FE) C)
(d) By substituting (4) into the definition of C, show that
N
[ P()C@di= PC
lb
and therefore the total expenditure is the product of price index times the quantity
index.
(©) (4) is the downward sloping demand curve. Draw two demand curves with
different values of ¢ in a diagram with P (7) plotted on the vertical axis and C'(j)
plotted on the horizontal axis. Clearly indicate which curve corresponds to a
high € and which curve corresponds to @ low e.
2. (firm’s problem): Bach firm produces a differentiated good with technology
Y@=H@)
H (3) is firm ?’s labor input. There is no price stickiness. Each firm chooses P (i) to
maximize profits defined as
PY @-WH()
subject to the demand constraint
Y@= 8)"e
Individual firms take aggregate price level P and aggregate consumption index C as
given.
(a) Show that the optimal price is
Pi=-
(HINT: profits can be written as (P (i) — W)Y (i) = (P (i) - W) (Bye)
(b) Let (i) denote the maximized profits. What is the ratio of profits to costs,
i.e., (i) / (WH (i)), for the firm which is optimally choosing P (i)? How does it
depend on the parameter «? Why does it so?
3. (equilibrium): Goods market clearing condition and labor market clearing condition
require
CO) =Y (i) for any 1 € [0,N]
N
a-[ H(i ai
Because of the symmetry between firms, we can easily find H (i) = H/N in equilibrium.
4 (a) Find the equilibrium aggregate consumption index C.
(b) Find the equilibrium relative price P (i) /P for any i € [0, N]
(©) Find the equilibrium real wage W/P.
(@) Find the labor share WH/PC and the profits share x (i) N/PC in equilibrium.
(@) Is the equilibrium allocation efficient? Answer yes or no, and explain why.
(f) Let’s do a simple comparative staties with respect to V. How do C, P (i) /P,
and W/P change when N gets larger? Give intuition for each of those.
