Jan Matteo Bassi

SID 21135602
Section L8 TuTh 3:00-4:20 pm
TA Emily Chen
ECON 2123: Macroeconomics
Problem Set #4
Due Date: December 6, 2024
Please find the answers to all sections of exercise 1 on the next page.

1. The Solow growth model with a Cobb-Douglas production function

In this question, you will study the Solow growth model with a Cobb-Douglas production
function. Consider the following model of economic growth:

K t +1=( 1−δ ) K t + I t
( 1)

α 1−α
Y t = At K t N t
( 2)

St =s Y t
( 3)

I t=S t
(4 )

At = A for all t
( 5)

N t =N for all t
( 6)

(a) (10 points) Is the production function (2) characterized by constant returns to scale?
Explain.
(b) (10 points) Transform the production function (2) into a relation between output per
worker, y t , and capital per worker, k t.
(c) (10 points) Show that k t+1 =( 1−δ ) k t + s A k tα.
(d) (10 points) Show that the steady-state level of capital per worker, k ¿, is given by

( )
1 / ( 1−α )
sA
.
δ

1
 ¿
(e) (10 points) Give an expression for output per worker in the steady state, y , and
consumption per worker in the steady state, c ¿. Assume that T =0, what is G ?
(f) (10 points) Explain what happens to the steady state output, Y ¿, and output per worker
¿
y , when N doubles.

2. Numerical analysis of the Solow model

Consider the model in question 1. Here, we will draw some figures using Excel or your
favorite software to understand the working of the Solow model.

(a) (10 points) Let s=0.4 , δ =0.4 , A=1 , α=1 /3 , and N=1 . Using the results in 1(d),
compute the value of k ¿ and y ¿.

(b) (10 points) Draw a graph similar to Figure 11-2 (i.e., plot y t , s y t , and δ k t against k t).
You may want to begin with constructing a grid for the value of k t between 0 and 2
spaced by 0.05 (HINT: look at my spreadsheet below).1

1
A useful EXCEL keyboard shortcut to switch between displaying formulas and their results: CTRL + ` (grave
accent).

2
Output per Worker, Investment per Worker, Deprecia-
Output, Investment, and Depreciation per
Worker
1.4
1.2
1
tion per Worker

0.8
0.6
0.4
0.2
0
0 1 2 3 4 5 6 7 8 9 1 1 2 3 4 5 6 7 8 9 2
0. 0. 0. 0. 0. 0. 0. 0. 0. 1. 1. 1. 1. 1. 1. 1. 1. 1.

Capital per Worker

(c) (10 points) Suppose that this economy in year 0 is very poor. Specifically, k 0=0.01.
Show how this economy grows between year 0 and year 50 using figures similar to
Figure 11-7. You need to plot y t and the growth rate of y t against t (HINT: look at
my spreadsheet below).

3
 50 Year Growth: Capital per Worker, Ouput per Worker, and
Growth Rate of Output per Worker
1.2 120
Capital per Worker, Output per Worker

1 100

Growth Rate of Output per Worker

0.6 60

0.4 40

0.2 20

0 0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50

Years

Capital per Worker Output per Worker Growth Rate of Output

(d) (10 points) How long does it take for this economy to grow half-way close to its
steady state? That is, after how many years does k t becomes greater than k ¿ / 2?

4
(e) (10 points) Suppose that the economy stays in a steady state associated with s=0.4
for t ≤ 5. Then, from year 6, the saving rate increases from 0.4 to 0.5 . Draw a graph
showing how y t evolves between year 0 and year 20, which should be similar to
Figure 11-4 (HINT: look at my spreadsheet below).

5
 (f) (10 points) Let’s find the golden rule saving rate, which maximizes the steady-state
¿
consumption per worker in this economy. Rather than analytically maximizing c with
respect to s ∈ [ 0 , 1 ] , we will use a numerical optimization toolbox in Excel. We first
need to add “Solver Add-in.” Select Excel Add-ins 2, click Go, select “Solver Add-in,”
and click Ok. Then, write a spreadsheet which calculates the value of c ¿ as a function
of s (HINT: look at my spreadsheet below).

¿
Then, open “Solver” under Data tab. Note that we want to maximize c by changing s
subject to the conditions that s ≥ 0 and s ≤1 . What is the golden rule saving rate sG
(HINT: look at my spreadsheet below)?

2
This link teaches you how to add or remove an Excel Add-in: https://support.microsoft.com/en-us/office/add-
or-remove-add-ins-in-excel-0af570c4-5cf3-4fa9-9b88-403625a0b460#OfficeVersion=macOS