Econ Exam Vault (UCSD)

ECON 110A Final Exam A Solutions
Name________________________
Prof. Levkoff
PID #_________________________
Fall Quarter 2014
Seat #________________________
Directions: You will have the full three hours to complete the exam after everyone has been
seated and the exam distributed. The exam is 12 pages (front and back). Additional scratch
paper is provided in the back of the exam. There are two parts- one short answer/free response
section and one problem solving/analysis section. To receive full credit, SHOW ALL WORK and
graphs where appropriate and CLEARLY BOX YOUR FINAL ANSWERS for any calculations.
Make sure your name, PID #, and seat # (for the seat you are physically sitting in) are on the
examination sheet before submitting your exam.
PartI:Evaluatethevalidityofeachofthefollowingstatementsusinggraphs,equations,andwritten
argumentswhereappropriate.(28points)
a) (7points)ComputingthegrowthrateofrealGDPinvolvesholdingquantitiesfixedand
allowingpricestofluctuatebetweenyears.
ANSWER:Thisisnotthecase.CalculatingthegrowthrateinrealGDPinvolves
holdingthepricesfixedinabaseyearandallowingthequantitiestofluctuate.In
instead,thestatementhadreplacedrealGDPwiththeCPI,thenthestatementwould
bevalid.
7pointsforbothexplanations
5pointsforonlyoneofthefollowingexplanations
b) (7points)Theloanablefundsmodelpredictsthatanincreasedbudgetdeficitwill
reduceinvestmentinequilibrium.
ANSWER:Thisisfairlyaccurate.Recallthatintheloanablefundsmodel,thesupply
curveisnationalsavings.Increasingthebudgetdeficitmeansreducingnational
savings(throughthereductioningovernmentsavings,thedeficit)whichputsupward
pressureontherealinterestrate,crowdingoutequilibriuminvestment.
7pointsforcorrectanswer(eitherwritten/diagrammatic,orsomecombinationof)
6pointsforthecorrectanswerbutfailtomentiontheinterestrateeffect
3pointsiftheygetthedirectionofthesavingsshiftortheinterestratemovement(or
both)wrong,butotherwiseanswerisconsistent
c) (7points)Thebathtubmodelofunemploymentisamodelofstructuralunemployment
usedtoexplainthesteadystatenaturalrateofunemploymentandsuggeststhatthe
longrunrateofunemploymentisincreasingintherateofjobseparationanddecreasing
intherateofjobfinding.
ANSWER:Thebathtubmodelofunemploymentisamodeloffrictional(NOT
structural,whichrecalliscausedbywagerigidity)unemployment.Theremainderof
thestatementregardingthesteadystaterateandtheeffectsofanincreaseintherate
ofjobseparationandadecreaseintherateofjobfindingsincethesteadystate
unemploymentrateinthebathtubmodelisU/L=s/(s+f).
3pointsforidentifyingthatstructuraliswrongandthatfrictionaliscorrect
4pointsforeitherprovingoridentifyingthes.slevelofU/Lforthebathtubmodel
thatverifiesthesecondhalfofthestatement.
d) (7points)Thekeyassumptiondrivingoutputpercapitatowardsthesteadystateinthe
Solowgrowthmodelwithpopulationgrowthistheincreasingmarginalproductof
capitalpercapita.
ANSWER:False.Thestatementwouldbecorrectifinsteaditreaddecreasing
marginalproductofcapitalpercapita.
7pointsforeitheridentifyinginwrittenargument(asabove)whatthecorrectversion
ofthestatementwouldbeORshowingonadiagramaconcavevs.convexproduction
functionandarguingthatweusedtheconcaveoneintheSolowmodel.Ifstudents
alsoarguethatitisdepreciationthatisthekeyopposingforcetosavings/investment
thatdrivesustothesteadystateintheSolowmodel,(whichitwouldregardlessof
returnstoscaleformanyspecifications),thisisalsoanacceptableanswerforfull
credit.
2pointsifstudentstryandsuggestthestatementwouldbecorrectifweeither
switchedSolowtoRomerortoCombinedSolowRomersincetheRomermodel
doesntusecapitalandthecombinedmodelstillutilizesdiminishingmarginalproduct
tocapital(sincetheexponentonKis1/3,capitalsshareofincome).
PartII:Analysis/Problems
#1)(32points)ConsiderthefollowingvariationoftheRomermodelwhereallexogenous
abovethecorrespondingparameter:
variableshavea
/
Theproductiontechnologyforaggregateoutputisdefinedby
, .
, .
Thelawofmotionforthestockofideasisgivenby
.
Theresourceconstraintforlaborisgivenby ,
,
Thefractionoftotallaborallocateddirectlytotheproductionideasisgivenby .
Theeconomyisendowedwithaninitialstockofideasgivenby .
a) (4points)Usethelawofmotionforthestockofideastowriteanexpressionfor
asafunctionoftheinitialstockofideas ,timet,andthegrowthrateofthestock
ofideas, .Howdoes dependononlytheexogenousmodelparameters?
Explain.
ANSWER:Dividingthelawofmotionforthestockofideasby yieldsthegrowth
.Sosinceweknowthat growsgeometricallyatarateof
rate
,
,thengivenitsinitialstockof ,wecancomputethevalueofthestockof
ideasatanygiventimeby
sothatanincrease
in , ,or wouldincreasethegrowthrateof .Increasesintheinitialstockof

knowledge increasethelevelof .
1pointforcorrectgrowthrateasafunctionofexogenousparameters
2pointsforcorrectformulafor givengeometricgrowthrate
1pointforexplainingatleast3ofthe4exogenouseffects.
b) (6points)Useyouranswerfroma)towriteanexpressionforoutputpercapitaasa
functionofalloftheexogenousmodelparametersandt,time.Whichexogenous
variablesexhibitgrowtheffectsonoutputpercapita?Whichonesexhibitlevel
effects?
ANSWER:Substitutinginfor intotheproductiontechnologyusingouranswer
froma)andtheremainingexogenousmodelparametersrecallingthat ,
,wefindthatoutputpercapitais
, ,and exhibitgrowtheffects. onlyexhibitsaleveleffecton . also

exhibitsaleveleffecton (soitexhibitsbothagrowthandleveleffect).
3pointsforcorrectlywritingoutexpressionforoutputpercapitadeductone
pointifinstead,studentwritesitastotaloutputforgettingtodivideby
1pointforcorrectgrowtheffects
1pointforcorrectleveleffect
1pointforidentifyingthat exhibitsboth
c) (4points)Whatistherateofgrowthofoutputpercapitaasafunctionofthe
exogenousmodelparameters?Explain.
ANSWER:Bytakingthelogtimederivativeoftheproductiontechnologyand
writingeverythingoutintermsofgrowthratesnotingthatthereisnogrowthin
thelaborforce ,wefindthat
%
wherethelastequalityfollowsfromthefactthatthelaborforceisfixed.
4pointsforcorrectgrowthrateinoutputpercapita(iftheyfailtodistinguish,still
givethemfullcreditsincetheansweristhesameanyhowsince isfixed).
2pointsifthemissthebutdoattempttodothegrowthaccountingabove
1pointiftheymissthebecausetheyforgettodothegrowthaccountingabove
Fortheremainderoftheproblem,wemaketwominoradjustmentstoaugmenttheRomermodelwith
someelementsoftheSolowmodelwithcapital( )accumulation.Namely,makethefollowingtwo
changes/additions:
Theproductiontechnologyisnowchangedto
/
,

Addthelawofmotionforaggregatecapitalgivenby
d) (6points)Usethelawofmotionforaggregatecapitaltofindarelationshipforthe
capitaltooutputratioalongabalancedgrowthpath(BGP)asafunctionofonly
exogenousmodelparametersbyassumingthatthegrowthrateofcapitalisequalto
.
ANSWER:Wearetoldtoassumethat
(bydividingthroughbyKto
getthegrowthrateonthelefthandsideofthelawofmotion).Notethattheleft
handsidebeingconstantalongaBGPimpliesthattherighthandsideofthe
equationisconstantalso,implyingthatthecapitaltoincomeratio
must
alsobeconstant.
Nopartialcredit
e) (6points)Useyouranswersfroma)d)tofindanexpressionforoutputpercapita
asafunctionofalloftheexogenousmodelparameters, ,andtime,t,inthe
combinedmodificationoftheRomerSolowmodel.
ANSWER:Theanswertothepreviouspartimpliesthefollowingrelationship
betweencapitalandoutputalongaBGP:
Wecansubstitutethisintothenewproductiontechnologyalongwithour
expressionfor and , justlikewedidinpartbtofindthat
5
Dividingthroughby yields
f)
3pointsforcorrectlysubstitutingintotheproductionfunctionforcapitalalong
theBGP
3pointsgivenanerrorinthepreviouspart,correctlyfindoutputpercapita
deductonepointagainiftheyforgettodividethroughby .
(6points)WhatisthegrowthrateofoutputpercapitaalongtheBGPinthe
combinedmodificationoftheSolowRomermodelexpressedasfunctionsofonly
exogenousparameters?Bywhatfactordoesthisgrowthrateexceedthegrowth
rateintheRomermodelwithoutthetwominoradjustments?Explain.
ANSWER:Againbygrowthaccountingwecanfindthat,usingthenewproduction
technology,
%
Whereagain,thelastequalityfollowsfromthefactthatthereisnogrowthin .
RecallingthatalongaBGP,theratioofY/Kwasconstant,sothatYandKmustalso
begrowingatthesamerates.Thisimpliesthat%
sothatthe
equationabovebecomes
Sothat
Sothatthegrowthrateofoutputpercapitainthecombinedmodelexceedsthat
oftheRomermodelwithoutcapitalaccumulationbyafactorof(3/8)/(1/4)=3/2,
whichisa50%increaseinthegrowthrate.
3pointsforcomputingthecorrectgrowthrateusingthegrowthaccounting
3pointsforidentifyingthatitexceedstheoriginalvaluebyafactorof(3/2)oran
increasein50%oftheoriginalmodelsgrowthrate(eitherisfine)
#2)(20points)Consideranindividualthatlivesforonlytwoperiods,tandt+1.Theconsumer,
asarational,forwardlookingindividual,wantstomaximizethesubjectivelydiscountedlifetime
,where isanexogenousparameter.
utilitygivenbytheexpression
/
Theinstantaneousutilityinagivenperiodisgivenbythefunction
inperiodstandt+1,
Theconsumerisendowedwithincome and
respectively.
Therateofreturnontheamountofincomesaved,s,fromperiodttot+1is
givenby .
a) (4points)Writeouttheresource(budget)constraintsfortheindividualforeach
period.
ANSWER:
Periodt:
Periodt+1:
2pointsforeachcorrectconstraint
Alsogivefullcreditifsomeoneusesthelifetimebudgetconstraintbyeliminatings
b) (4points)Writeouttheindividualsintertemporaloptimizationproblemasa
functionoftheamountofincomesaved,s,byusingyouranswersfroma).
ANSWER:Theagentsolves
subjecttotheconstraintsina)
,
Substitutingtheconstraintsdirectlyintotheobjectivefunction,wefindthatthe
agentslifetimeutilitymaximizationproblemcanberewrittenas
/
wherethesecondequationfollowsfromdirectlysubstitutingtheconstraintsfrom
a)intotheobjectivefunction.
4pointsforcorrectlywritingoutthemaximizationproblemasafunctionofthe
savingsrates(eveniftheydidntusethefunctionalformoftheutilityfunction
provided)
2pointsiftheyonlywritetheoptimizationproblemoutasfunctionof
consumptionineachperiod.
c) (6points)Derivethefirstorderconditionwithrespecttosavings,s,andinterpret
yourresults.Explaintheintuition.(hint:itmaybeusefultoconsidertherolesof
and
intheexplanation)
ANSWER:Thefirstorderconditionwithrespecttos,thequantitysavedinthe
present,isgivenby

Followingthehint,wecansubstitutebackinfortheconsumptionvaluesusingthe
constraintsinthereversedirectionandnotethatthefirstorderconditionisalso
equivalentto

ThisistheEulerconsumptionequationthatexplainstheoptimalsavingsbehavior.
Itsuggeststhattheindividualoptimallyallocateshisconsumptionuntilthe
marginalutilityofwhatisgivenuptoday(lefthandside)isjustoffsetbythe
subjectivelydiscountedfuturereturnonthemarginalutilitygainedinthefuture
(righthandside).Thatis,theindividualisoptimallyallocatinghisconsumption
acrossperiodsifheisjustindifferentbetweensavingthelastunitforthefutureor
consumingittoday.
3pointsforthecorrectFOC
3pointsforthecorrectlyidentifyingandinterpretingtheEulerequation(evenif
theydidntusethehint,theyshouldhavebeenabletoexplainthisidea)
d) (6points)Computetheoptimalvalueofsavings, . Howdoesthisvaluedepend
?Explaintheintuition.
on , ,and
ANSWER:Bysimplifyingthefirstordercondition(theEulerequation),andusing
theconstraints,wecanfindthat
Notethatas increases(astheagentbecomesmorepatient),thefirstfraction
getsbiggerwhilethesecondfraction(whatisbeingsubtracted)getssmaller,
resultingintheentiresavingsgettinglarger.Thisshouldmakesenseasthe
agentbecomesmorepatientandplacesmoresubjectiveweightonthefuture,
he/shewillsavemore.Thesameeffectistrueforpresentincome.Themore
theagentisendowedwithinthepresent,themorehewillbeabletosaveforthe
future.Theoppositeistrueforfutureincome.Iftheagentexpectstoreceivea
higherfutureincomeendowmentof
,thenhewillnotneedtosaveasmuch
toconsumethesameamountinthefuture.
3pointsforthecorrectsavingsfunction(doesnthavetobeidenticallysimplified)
1pointforthecorrecteffectofeachofthe3exogenousparameters(3points
total)
#3)(20points)Usingthetermsvelocity,inflation,outputandmoneysupply,explainwhat
theoryexplainsthephenomenaobservableinthedatabelow.Inwhattimeframedoesthe
theoryapply?Explain.
ANSWER:Thephenomenaobservableinthedataabovecanbeexplainedbythequantity
theoryofmoneydescribedbythequantityequation
sincevelocityremainsfairlyconstant.Takingthelogderivativeandrewritingintermsof
% sothatanygrowthinthe
growthrates,thisimpliesthat %
%
moneysupplyinexcessofthegrowthinoutputwilltranslateintolongruninflation.(same
argumentcanbemadeifweassumemoneyisneutralinthelongrunansothat%
resultingfromachangeinthemoneysupplyduetotheclassicaldichotomy)
2pointsformentioningeachofthosekeywords(8pointstotal)
4pointsforwritingoutthecorrectquantitytheoryrelationshipMV=PY(inlevelof
percentagechangeformregardlessofwhatisassumedtobeconstantprovideditis
explained)
4pointsforidentifyingtherelationshipbetweengrowthrateinthemoneysupplyandthe
inflationrate
4pointsformentioningthatthetheoryonlyappliesinexplaininglongrunphenomena
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12
ECON 110A Final Exam B Solutions
Name________________________
Prof. Levkoff
PID #_________________________
Fall Quarter 2014
Seat #________________________
a) (7points)Thekeyassumptiondrivingoutputpercapitatowardsthesteadystateinthe
Solowgrowthmodelwithpopulationgrowthistheincreasingmarginalproductof
capitalpercapita.
ANSWER:False.Thestatementwouldbecorrectifinsteaditreaddecreasing
marginalproductofcapitalpercapita.
7pointsforeitheridentifyinginwrittenargument(asabove)whatthecorrectversion
ofthestatementwouldbeORshowingonadiagramaconcavevs.convexproduction
functionandarguingthatweusedtheconcaveoneintheSolowmodel.Ifstudents
alsoarguethatitisdepreciationthatisthekeyopposingforcetosavings/investment
thatdrivesustothesteadystateintheSolowmodel,(whichitwouldregardlessof
returnstoscaleformanyspecifications),thisisalsoanacceptableanswerforfull
credit.
2pointsifstudentstryandsuggestthestatementwouldbecorrectifweeither
switchedSolowtoRomerortoCombinedSolowRomersincetheRomermodel
doesntusecapitalandthecombinedmodelstillutilizesdiminishingmarginalproduct
tocapital(sincetheexponentonKis1/3,capitalsshareofincome).
b) (7points)Computingthegrowthrateoftheconsumerpriceindexinvolvesholding
pricesfixedandallowingthequantitiespurchasedtofluctuatebetweenyears.
ANSWER:Thisisnotthecase.CalculatingthegrowthrateintheCPIinvolvesholding
thequantitiesfixedinabaseyearbasketandallowingthepricestofluctuate.If
instead,thestatementhadreplacedtheCPIwithrealGDP,thenthestatementwould
bevalid.
7pointsforbothexplanations
5pointsforonlyoneofthefollowingexplanations
c) (7points)Thebathtubmodelofunemploymentisamodelofstructuralunemployment
usedtoexplainthesteadystatenaturalrateofunemploymentandsuggeststhatthe
longrunrateofunemploymentisincreasingintherateofjobseparationanddecreasing
intherateofjobfinding.
ANSWER:Thebathtubmodelofunemploymentisamodeloffrictional(NOT
structural,whichrecalliscausedbywagerigidity)unemployment.Theremainderof
thestatementregardingthesteadystaterateandtheeffectsofanincreaseintherate
ofjobseparationandadecreaseintherateofjobfindingsincethesteadystate
unemploymentrateinthebathtubmodelisU/L=s/(s+f).
3pointsforidentifyingthatstructuraliswrongandthatfrictionaliscorrect
4pointsforeitherprovingoridentifyingthes.slevelofU/Lforthebathtubmodel
thatverifiesthesecondhalfofthestatement.
d) (7points)Theloanablefundsmodelpredictsthatareducedbudgetdeficitwillincrease
investmentinequilibrium.
ANSWER:Thisisfairlyaccurate.Recallthatintheloanablefundsmodel,thesupply
curveisnationalsavings.Reducingthebudgetdeficitmeansincreasingnational
savings(throughtheincreaseingovernmentsavings,thedeficitreduction)whichputs
downwardpressureontherealinterestrate,increasingtheequilibriumquantityof
investment.
7pointsforcorrectanswer(eitherwritten/diagrammatic,orsomecombinationof)
6pointsforthecorrectanswerbutfailtomentiontheinterestrateeffect
3pointsiftheygetthedirectionofthesavingsshiftortheinterestratemovement(or
both)wrong,butotherwiseanswerisconsistent
PartII:Analysis/Problems
#1)(20points)Usingthetermsnominalinterestrate,realinterestrate,inflationrateandthe
moneysupply,explainthecausaleffectobservableinthedatabelow.Inwhattimeframedoes
thetheoryapply?Explain.
ANSWER:ThephenomenaobservableinthedataabovecanbeexplainedbytheFisher
effect:
Foraparticularrealinterestrate(whichisdeterminedbysavingsandinvestmentinthe
capital/loanablefundsmarket),theFisherequationimpliesthatnominalinterestrates
andinflationratesshouldmoveverycloselytogetherinthelongrun,whentheinflation
rateisdeterminedbythegrowthrateofthemoneysupply.
2pointsformentioningeachofthosekeywords(8pointstotal)
4pointsforwritingoutthecorrectFisherequation(ifstudentsprovidetheexactformula
includingtheextra
term,thatisfine)
4pointsforidentifyingtherelationshipbetweeninflationrateandnominalinterestrate
4pointsformentioningthatthetheoryappliestothelongruntrendofthesevariables
#2)(20points)Consideranindividualthatlivesforonlytwoperiods,tandt+1.Theconsumer,
asarational,forwardlookingindividual,wantstomaximizethesubjectivelydiscountedlifetime
/
Theinstantaneousutilityinagivenperiodisgivenbythefunction
inperiodstandt+1,
Theconsumerisendowedwithincome and
respectively.
Therateofreturnontheamountofincomesaved,s,fromperiodttot+1is
givenby .
period.
ANSWER:
Periodt:
Periodt+1:
2pointsforeachcorrectconstraint
Alsogivefullcreditifsomeoneusesthelifetimebudgetconstraintbyeliminatings
b) (4points)Writeouttheindividualsintertemporaloptimizationproblemasa
functionoftheamountofincomesaved,s,byusingyouranswersfroma).
ANSWER:Theagentsolves
subjecttotheconstraintsina)
,
Substitutingtheconstraintsdirectlyintotheobjectivefunction,wefindthatthe
agentslifetimeutilitymaximizationproblemcanberewrittenas
/
wherethesecondequationfollowsfromdirectlysubstitutingtheconstraintsfrom
a)intotheobjectivefunction.
4pointsforcorrectlywritingoutthemaximizationproblemasafunctionofthe
savingsrates(eveniftheydidntusethefunctionalformoftheutilityfunction
provided)
2pointsiftheyonlywritetheoptimizationproblemoutasfunctionof
consumptionineachperiod.
c) (6points)Derivethefirstorderconditionwithrespecttosavings,s,andinterpret
yourresults.Explaintheintuition.(hint:itmaybeusefultoconsidertherolesof
and
intheexplanation)
ANSWER:Thefirstorderconditionwithrespecttos,thequantitysavedinthe
present,isgivenby
/
Followingthehint,wecansubstitutebackinfortheconsumptionvaluesusingthe
constraintsinthereversedirectionandnotethatthefirstorderconditionisalso
equivalentto

ThisistheEulerconsumptionequationthatexplainstheoptimalsavingsbehavior.
Itsuggeststhattheindividualoptimallyallocateshisconsumptionuntilthe
marginalutilityofwhatisgivenuptoday(lefthandside)isjustoffsetbythe
subjectivelydiscountedfuturereturnonthemarginalutilitygainedinthefuture
(righthandside).Thatis,theindividualisoptimallyallocatinghisconsumption
acrossperiodsifheisjustindifferentbetweensavingthelastunitforthefutureor
consumingittoday.
3pointsforthecorrectFOC
3pointsforthecorrectlyidentifyingandinterpretingtheEulerequation(evenif
theydidntusethehint,theyshouldhavebeenabletoexplainthisidea)
d) (6points)Computetheoptimalvaluesofvalueofsavings, . Howdoesthisvalue
?Explaintheintuition.
dependon , ,and
ANSWER:Bysimplifyingthefirstordercondition(theEulerequation),andusing
theconstraints,wecanfindthat
Notethatas increases(astheagentbecomesmorepatient),thefirstfraction
getsbiggerwhilethesecondfraction(whatisbeingsubtracted)getssmaller,
resultingintheentiresavingsgettinglarger.Thisshouldmakesenseasthe
agentbecomesmorepatientandplacesmoresubjectiveweightonthefuture,
he/shewillsavemore.Thesameeffectistrueforpresentincome.Themore
theagentisendowedwithinthepresent,themorehewillbeabletosaveforthe
future.Theoppositeistrueforfutureincome.Iftheagentexpectstoreceivea
higherfutureincomeendowmentof
,thenhewillnotneedtosaveasmuch
toconsumethesameamountinthefuture.
3pointsforthecorrectsavingsfunction(doesnthavetobeidenticallysimplified)
1pointforthecorrecteffectofeachofthe3exogenousparameters(3points
total)
variableshavea
/
, .
, .
.
,
Explain.
rate
,
sothatanincrease

effects?
, ,and exhibitgrowtheffects. onlyexhibitsaleveleffecton . also

exhibitsaleveleffecton (soitexhibitsbothagrowthandleveleffect).
%
2pointsifthemissthe1/5butdoattempttodothegrowthaccountingabove
1pointiftheymissthe1/5becausetheyforgettodothegrowthaccounting
above
changes/additions:
/
,

.
must
alsobeconstant.
Nopartialcredit
e) (6points)Useyouranswersfroma)d)tofindanexpressionforoutputpercapitaas
afunctionofalloftheexogenousmodelparameters, ,andtime,t,inthe
/
f)
theBGP
technology,
%
sothatthe
Sothat
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12
ECON 110A Midterm Exam 2A Solutions
Name________________________
Prof. Levkoff
PID #_________________________
Fall Quarter 2014
Seat #________________________
Directions: You will have an hour and twenty minutes to complete the exam after everyone has
been seated and the exam distributed. The exam is 10 pages (front and back). Additional scratch
a) (10points)TheSolowmodelpredictsthatpoorercountriesshouldgrowrelativelyfasterthan
wealthiercountries(intermsofpercapitaincome).However,sincewestillobservesomepoor
economiesthatgrowslowlyandricheconomiesthatgrowquickly,theSolowgrowthmodel
mustbemakinganincorrectprediction.
ANSWER:Thisisnotthecase.TheSolowmodelpredictsconditionalconvergencethateach
countrywillgrowtowardsitsownuniquesteadystate.Thestatementwouldbecorrectifit
alsomadethequalification,allotherthingsequal(orceterisparibus).Ifcountriesdont
havethesameunderlyingeconomicclimate(describedbytheexogenousfactorsinour
model),thentheireconomieswillgrowtodifferentsteadystatesatdifferentspeeds.
3pointsformentioningconditionalconvergence
7pointsformentioningthatSolowmakesaceterisparibusassumption(ortheequivalent)
b) (10points)IntheSolowmodelwithpopulationgrowth,theconsumptionfunctionexhibits
diminishingmarginalpropensitytoconsume.
ANSWER:False.TheconsumptionfunctionfortheSolowmodelisjust
.Sothe
consumptionfunctionislinearinincomeimplyingthattheMPCisaconstantandequalto1s.
3pointsforcorrectlywritingouttheconsumptionfunction(ordrawingit)
6pointsforcorrectlyarguingthatitdoesnotexhibitdiminishingMPCinincome
1pointiftheymentionthatitexhibitsconstantMPC
c) (10points)TheSolowmodelwithpopulationgrowthandtechnologicalprogresspredictsthat,
inthelongrunsteadystate,aneconomysratioofcapitaltoincomewillbeapproximately
constant.
ANSWER:Thisistrue.Y/Lgrowsatarateofginthemodel,therateofexogenous
technologicalprogress.SodoesK/L.Thus,theratioofY/LtoK/L,orY/Kmustnotbegrowing
atall.
5pointsforcorrectlyidentifyingthatY/LandK/Lgrowatthesamerate
5pointsforarguingthatthisimpliesthatY/Kmustbeconstantinthemodel.
PartII:Problems&Analysis(70points)
#1)(21points)Considerthefollowingdataonthegrowthrateofworldwideincome(GDP)percapita:
Years
01700
17001820
18201913
19131950
19501970
19701990
19902014
20142050
20502070
20702100
WorldwideIncomePerCapita
AnnualizedGrowthRate
0.0%
0.1%
0.9%
0.9%
2.8%
1.3%
1.9%
2.5%
1.5%
1.2%
a) (7points)Ifthecurrentworldwideaverageincomepercapitaisapproximately$14,000
(measuredin2014baseyearUSdollars),computetheapproximateleveloftheworldwide
averageincomeinyearzero(in2014baseyearUSdollars)aspreciselyaspossible.
ANSWER:Sincethereis0%growthfrom01700,allwereallyneedtodoisfindthelevelof
incomeperpersonin1700byapplyingthegrowthratesbackwards:
/
/
$ ,
.
.
.
.
.
$ ,
. (in
2014dollars).
Deduct2pointsifthemethodologylookscorrect,butthereisasmalldiscrepancycounting
theyears.
Deduct2morepointsiftheyusethewronggrowthrates.
Nopartialcreditotherwiseifbothofthesemistakesaremade
b) (7points)Ifthefutureforecastsprovidedareaccurate,computeaprojectionfortheworldwide
averageincomepercapitain2100(measuredin2014baseyeardollars)aspreciselyaspossible.
ANSWER:Nowwejustprojectthecurrent$14,000incomeforwardtotheyear2100:
/
$ ,
.
.
.
$ ,
. (in2014dollars).
theyears.
c) (7points)Ifthegrowthprojectionsareinstead,expectedtoremainat2.5%through2100,by
whatfactorwilltheprojectedworldwideaverageincomein2100(measuredincurrent2014
dollars)increaserelativetoyouranswerinb)?
ANSWER:Nowwejustprojectthecurrent$14,000incomeforwardtotheyear2100assuming
aconstantrateof2.5%andcomparetheresultingfigurewithouranswerfromb):
/
$ ,
.
$
,
. (in2014dollars).Thisisprecisely
$
,
. / $ ,
.
. timesasgreataswhenweprojectedthatgrowth
wouldslowdown.Thatis,ifincomegrowthremainsataround2.5%,thestandardofliving
wouldbealmostdouble(1.78)whatitwouldbewiththepredictedslowdown.
theyears.
NopartialcreditotherwiseifbothofthesemistakesaremadeANDthestudentsgetthefactor
incorrect(ifthefactoriswrongbecauseofacarrythrougherrorbutotherwise,wouldhave
beencorrect,donotdeductonly1morepointfromtheprevious4thatweredeductedfor
makingmultiplematherrors).
#2)(49points)ConsiderthebaselineSolowgrowthmodelthatalsoincorporatespopulation
.Thepopulationgrowsatan
growth.Theproductiontechnologyisgivenby
,
exogenousrateof1%.Thedepreciationrateoncapitalisexogenousandequalto9%.Assume
consumerssaveaconstantexogenousfraction oftheirincomeinanygivenperiod.
a) (7points)Derivethepercapitaproductionfunction
where
/ and
/
.Whatpropertyoftheproductiontechnologyguaranteesthatyoucandothis?Explain.
ANSWER:
.Wecouldonlydothisbecausethe
technologyexhibitsconstantreturnstoscale.
7pointsforcorrectproductionfunctionandmentioningCRS
4pointsforonlyprovidingoneofthese
b) (7points)Derivethelawofmotionforthecapitalstockpercapita, ,asafunctionofonly
capitalpercapita, . Ifweweretogivethiseconomysomeamountofstartingcapital, ,
andthenletitgrowtowardsitssteadystatethroughthecapitalaccumulationprocess,what
valueof
wouldinducethehighestgrowthrateasthecountryconvergestowardsits
steadystate?(hint:useyourworkfromb),tofindthevalueasafunctionofthesavingsrate,
).
ANSWER:
. .Ifweweretostarttheeconomyoffwith
someinitialamountofcapital,
,onatrajectorythatwillprovidethehighestinitial
growthink(thecorrespondinglylargest/maximalvaluefor ),thenwejustneedto
findthelevelofkthatmaximizes bysolving:

.
Thecorrespondingfirstorderconditionforthemaximizationproblemyields
Whichcanbesolvedfor
4pointsforthelawofmotion
3pointsforcorrectlyoptimizingittofindk_0
c) (7points)Computethesteadystatevalues
b).
5
, and
usingyouranswerfrom

ANSWER:Usingourlawofmotionforcapitalandsettingittozero(imposingthesteady
statecondition),wefindthatthesteadystatelevelofcapital mustsatisfy
.
Substitutingthisintotheproductionfunctionyields
Substitutingthisintotheconsumptionfunctionyields
3pointsforcorrectk*(ifdonecorrectlywithacarrythrougherrorfromthelawof
motion,awardcredit)
2pointsforcorrecty*(ifdonecorrectlywithacarrythrougherrorfromcalculatingk*,
awardcredit)
2pointsforcorrectc*(ifdonecorrectlywithacarrythrougherrorfromcalculatingy*,
awardcredit)
d) (7points)Computethevalueofthesavingsrate, ,thatmaximizesthesteadystate
.Showyourwork!
consumptionprofile bysolvingtheproblem,
Fromthepreviouspart,wefoundthat
Nowallweneedtodoismaximizethisexpressionwithrespecttosbysolving:
Wherethesecondequalityabovecomesfromnotingthatwecanpullouttheconstant10
anditwillnotaffecttheoptimizationproblem(ifyoukeepit,youwillseethatitwill
canceloutanywayonceyoutakethefirstordercondition).
5pointsforwritingouttheoptimizationproblemandtakingthefirstorderconditions
correctly
2pointsforfindingthecorrectvalue(Iprovedingeneral,thatthisvaluewillbeequalto
capitalsshareofincomeandsomestudentsmaytryandcircumventactuallysolvingthe
optimizationproblemtoprovethisinthisevent,awardthese3pointsiftheyadequately
explainthatweprovedthatcapitalssharewillequaltheoptimalsavingsrateintheCobb
Douglascase,butDONOTawardthe4pointssincetheydidnotfollowthedirections)
e) (7points)Whatotherconditionmust satisfyifconsumptionismaximizedinthe
steadystate?Explainusingadiagram.
6

ANSWER:Ifweareusingthegoldenrule,then mustalsosatisfy
needtoverifythatitactuallydoesweknowitmust).
f)
(no
Notethatthedepreciationlineisjustourbreakeveninvestmentfunctionwhichalso
accountsforpopulationgrowthinthecasewhereitisnotzero.
7pointsforexplicitlymentioningtheconditionanddrawingthediagram
5pointsforonlydoingoneofthese
(7points)Ifinstead,theaggregateproductionfunctionisgivenby
,
,for
whatvaluesofthesavingsratewilltheeconomygrowforever?Atwhatratewillcapitaland
output(percapita)grow?Explain.(hint:adiagrammayhelpyouhere)
ANSWER:Withthenewproductionfunction,ourlawofmotionforparcapitalpercapita
changesslightlysincewenowareusing
.Thenewlawofmotionforthe
capitalstockisgivenby
.
Dividingthroughbykandrecognizingthaty=kimplies%
% letsusrewritethe
lawofmotionintermsofgrowthrates:
%
.
%
Thus,theeconomywillexhibitpositiveperpetualgrowthifandonlyif
%.Therate
ofgrowthaboveisdeterminedbytheamountwhichthesavingsrateexceedsthenet
depreciationandpopulationgrowthrates.
g) (7points)Explainwhytheadjustmenttothemodelinf)providesamoreaccurate
predictionintermsofwhatwewouldexpecttohappentoincomeandtherealwageinthe
7
longrunincomparisontotheproductionmodelintheoriginalquestion,whichfaced
diminishingmarginalreturnstocapital?Assumethattheinputmarketsareinequilibrium.
ANSWER:Themodelinf)incorporatesendogenousgrowth,wherebytheeconomynever
reachesasteadystateprovidedsavingsissufficientlyhigh.Thisisamuchmorerealistic
descriptionofactualphenomenacomparedtotheearlierpartsofthequestionthathas
modeledproductioninawaysuchthattheeconomyslowsdowntoasteadystatewhere
K/Ldoesntgrow(duetodiminishingreturnstok).
Iftherealwagetracksaveragelaborproductivity(Y/L)andYisgrowingforever,thenwe
wouldexpectthismodelalsopredictsthattherealwageshouldalsogrow.Inthe
previouspartsoftheproblemwhereweusetheSolowmodelwithoutendogenous
growth(assumingdiminishingreturnstok),thesteadystategrowthrateofY/Liszero,
predictingabsolutelyzerogrowthintherealwage(unrealistic).
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10
ECON 110A Midterm Exam 2B Solutions
Name________________________
Prof. Levkoff
PID #_________________________
Fall Quarter 2014
Seat #________________________
a) (10points)TheSolowmodelpredictsthatpoorercountriesshouldgrowrelativelyfasterthan
wealthiercountries(intermsofpercapitaincome).However,sincewestillobservesomepoor
economiesthatgrowslowlyandricheconomiesthatgrowquickly,theSolowgrowthmodel
mustbemakinganincorrectprediction.
ANSWER:Thisisnotthecase.TheSolowmodelpredictsconditionalconvergencethateach
countrywillgrowtowardsitsownuniquesteadystate.Thestatementwouldbecorrectifit
alsomadethequalification,allotherthingsequal(orceterisparibus).Ifcountriesdont
havethesameunderlyingeconomicclimate(describedbytheexogenousfactorsinour
model),thentheireconomieswillgrowtodifferentsteadystatesatdifferentspeeds.
3pointsformentioningconditionalconvergence
7pointsformentioningthatSolowmakesaceterisparibusassumption(ortheequivalent)
b) (10points)TheSolowmodelwithpopulationgrowthandtechnologicalprogresspredictsthat,
inthelongrunsteadystate,aneconomysratioofcapitaltoincomewillbeapproximately
constant.
ANSWER:Thisistrue.Y/Lgrowsatarateofginthemodel,therateofexogenous
technologicalprogress.SodoesK/L.Thus,theratioofY/LtoK/L,orY/Kmustnotbegrowing
atall.
5pointsforcorrectlyidentifyingthatY/LandK/Lgrowatthesamerate
5pointsforarguingthatthisimpliesthatY/Kmustbeconstantinthemodel.
c) (10points)IntheSolowmodelwithpopulationgrowth,theconsumptionfunctionexhibits
diminishingmarginalpropensitytoconsume.
ANSWER:False.TheconsumptionfunctionfortheSolowmodelisjust
.Sothe
consumptionfunctionislinearinincomeimplyingthattheMPCisaconstantandequalto1s.
3pointsforcorrectlywritingouttheconsumptionfunction(ordrawingit)
6pointsforcorrectlyarguingthatitdoesnotexhibitdiminishingMPCinincome
1pointiftheymentionthatitexhibitsconstantMPC
#1)(49points)ConsiderthebaselineSolowgrowthmodelthatalsoincorporatespopulation
growth.Theproductiontechnologyisgivenby
,
.Thepopulationgrowsatan
exogenousrateof1%.Thedepreciationrateoncapitalisexogenousandequalto4%.Assume
consumerssaveaconstantexogenousfraction oftheirincomeinanygivenperiod.
a) (7points)Derivethepercapitaproductionfunction
where
/ and
/
.Whatpropertyoftheproductiontechnologyguaranteesthatyoucandothis?Explain.
ANSWER:
.Wecouldonlydothisbecausethe
technologyexhibitsconstantreturnstoscale.
7pointsforcorrectproductionfunctionandmentioningCRS
4pointsforonlyprovidingoneofthese
b) (7points)Derivethelawofmotionforthecapitalstockpercapita, ,asafunctionofonly
capitalpercapita, . Ifweweretogivethiseconomysomeamountofstartingcapital, ,
andthenletitgrowtowardsitssteadystatethroughthecapitalaccumulationprocess,what
valueof
wouldinducethehighestgrowthrateasthecountryconvergestowardsits
steadystate?(hint:useyourworkfromb),tofindthevalueasafunctionofthesavingsrate,
).
ANSWER:
.
.Ifweweretostarttheeconomyoff
withsomeinitialamountofcapital,
,onatrajectorythatwillprovidethehighest
initialgrowthink(thecorrespondinglylargest/maximalvaluefor ),thenwejustneed
tofindthelevelofkthatmaximizes bysolving:
Thecorrespondingfirstorderconditionforthemaximizationproblemyields
Whichcanbesolvedfor
4pointsforthelawofmotion
3pointsforcorrectlyoptimizingittofindk_0
c) (7points)Computethesteadystatevalues , , and usingyouranswerfrom

b).
ANSWER:Usingourlawofmotionforcapitalandsettingittozero(imposingthesteady
statecondition),wefindthatthesteadystatelevelofcapital mustsatisfy
.
Substitutingthisintotheproductionfunctionyields
Substitutingthisintotheconsumptionfunctionyields
3pointsforcorrectk*(ifdonecorrectlywithacarrythrougherrorfromthelawof
motion,awardcredit)
2pointsforcorrecty*(ifdonecorrectlywithacarrythrougherrorfromcalculatingk*,
awardcredit)
2pointsforcorrectc*(ifdonecorrectlywithacarrythrougherrorfromcalculatingy*,
awardcredit)
d) (7points)Computethevalueofthesavingsrate, ,thatmaximizesthesteadystate
consumptionprofile bysolvingtheproblem,
.Showyourwork!
Fromthepreviouspart,wefoundthat
Nowallweneedtodoismaximizethisexpressionwithrespecttosbysolving:
Wherethesecondequalityabovecomesfromnotingthatwecanpullouttheconstant20
anditwillnotaffecttheoptimizationproblem(ifyoukeepit,youwillseethatitwill
canceloutanywayonceyoutakethefirstordercondition).
5pointsforwritingouttheoptimizationproblemandtakingthefirstorderconditions
correctly
2pointsforfindingthecorrectvalue(Iprovedingeneral,thatthisvaluewillbeequalto
capitalsshareofincomeandsomestudentsmaytryandcircumventactuallysolvingthe
optimizationproblemtoprovethisinthisevent,awardthese3pointsiftheyadequately
explainthatweprovedthatcapitalssharewillequaltheoptimalsavingsrateintheCobb
Douglascase,butDONOTawardthe4pointssincetheydidnotfollowthedirections)
e) (7points)Whatotherconditionmust satisfyifconsumptionismaximizedinthe
steadystate?Explainusingadiagram.
ANSWER:Ifweareusingthegoldenrule,then mustalsosatisfy
(no
needtoverifythatitactuallydoesweknowitmust).
Notethatthedepreciationlineisjustourbreakeveninvestmentfunctionwhichalso
accountsforpopulationgrowthinthecasewhereitisnotzero.
7pointsforexplicitlymentioningtheconditionanddrawingthediagram
5pointsforonlydoingoneofthese
5
f)
(7points)Ifinstead,theaggregateproductionfunctionisgivenby
,
,for
whatvaluesofthesavingsratewilltheeconomygrowforever?Atwhatratewillcapitaland
output(percapita)grow?Explain.(hint:adiagrammayhelpyouhere)
ANSWER:Withthenewproductionfunction,ourlawofmotionforparcapitalpercapita
changesslightlysincewenowareusing
.Thenewlawofmotionforthe
capitalstockisgivenby
Dividingthroughbykandrecognizingthaty=kimplies%
% letsusrewritethe
lawofmotionintermsofgrowthrates:
%
.
%
Thus,theeconomywillexhibitpositiveperpetualgrowthifandonlyif
%.Therate
ofgrowthaboveisdeterminedbytheamountwhichthesavingsrateexceedsthenet
depreciationandpopulationgrowthrates.
g) (7points)Explainwhytheadjustmenttothemodelinf)providesamoreaccurate
predictionintermsofwhatwewouldexpecttohappentoincomeandtherealwageinthe
longrunincomparisontotheproductionmodelintheoriginalquestion,whichfaced
diminishingmarginalreturnstocapital?Assumethattheinputmarketsareinequilibrium.
ANSWER:Themodelinf)incorporatesendogenousgrowth,wherebytheeconomynever
reachesasteadystateprovidedsavingsissufficientlyhigh.Thisisamuchmorerealistic
descriptionofactualphenomenacomparedtotheearlierpartsofthequestionthathas
modeledproductioninawaysuchthattheeconomyslowsdowntoasteadystatewhere
K/Ldoesntgrow(duetodiminishingreturnstok).
Iftherealwagetracksaveragelaborproductivity(Y/L)andYisgrowingforever,thenwe
wouldexpectthismodelalsopredictsthattherealwageshouldalsogrow.Inthe
previouspartsoftheproblemwhereweusetheSolowmodelwithoutendogenous
growth(assumingdiminishingreturnstok),thesteadystategrowthrateofY/Liszero,
predictingabsolutelyzerogrowthintherealwage(unrealistic).
#2)(21points)Considerthefollowingdataonthegrowthrateofworldwideincome(GDP)percapita:
Years
01700
17001820
18201913
19131950
19501970
19701990
19902014
20142050
20502070
20702100
WorldwideIncomePerCapita
AnnualizedGrowthRate
0.0%
0.1%
0.9%
0.9%
2.8%
1.3%
1.9%
2.5%
1.5%
1.2%
a) (7points)Ifthecurrentworldwideaverageincomepercapitaisapproximately$13,000
(measuredin2014baseyearUSdollars),computetheapproximateleveloftheworldwide
averageincomeinyearzero(in2014baseyearUSdollars)aspreciselyaspossible.
ANSWER:Sincethereis0%growthfrom01700,allwereallyneedtodoisfindthelevelof
incomeperpersonin1700byapplyingthegrowthratesbackwards:
/
/
$ ,
.
.
.
.
.
$ ,
. (in
2014dollars).
theyears.
b) (7points)Ifthefutureforecastsprovidedareaccurate,computeaprojectionfortheworldwide
averageincomepercapitain2100(measuredin2014baseyeardollars)aspreciselyaspossible.
ANSWER:Nowwejustprojectthecurrent$14,000incomeforwardtotheyear2100:
/
$ ,
.
.
.
$ ,
. (in2014dollars).
theyears.
c) (7points)Ifthegrowthprojectionsareinstead,expectedtoremainat2.5%through2100,by
whatfactorwilltheprojectedworldwideaverageincomein2100(measuredincurrent2014
dollars)increaserelativetoyouranswerinb)?
ANSWER:Nowwejustprojectthecurrent$13,000incomeforwardtotheyear2100assuming
aconstantrateof2.5%andcomparetheresultingfigurewithouranswerfromb):
/
$ ,
.
$
,
. (in2014dollars).Thisisprecisely
$
,
. / $ ,
.
. timesasgreataswhenweprojectedthatgrowth
wouldslowdown.Thatis,ifincomegrowthremainsataround2.5%,thestandardofliving
wouldbealmostdouble(1.78)whatitwouldbewiththepredictedslowdown.
theyears.
NopartialcreditotherwiseifbothofthesemistakesaremadeANDthestudentsgetthefactor
incorrect(ifthefactoriswrongbecauseofacarrythrougherrorbutotherwise,wouldhave
beencorrect,donotdeductonly1morepointfromtheprevious4thatweredeductedfor
makingmultiplematherrors).
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10
ECON 110A Midterm Exam 1A Solutions
Name________________________
Prof. Levkoff
PID #_________________________
Fall Quarter 2014
Seat #________________________
a) (10points)ConsideracountrythatproducesoutputusingonlycapitalandlaborwithaCobb
Douglastechnology.Ifthemarginalproductofcapitalis3andtheaverageproductofcapitalis
10,thenlaborssharemakesup70%ofthetotalnationalincome.Assumethatthelaborand
capitalmarketsareinequilibrium.
ANSWER:RecallthatforaCobbDouglastechnology,
capitalsshareofincome.Substitutingtheinformationgiven,itmustbethecasethat
%.Thisimpliesthatlaborsshareofnationalincomeisequalto70%asstated
accuratelyabove.
5pointsforrecallingthattheratioofthemarginalproducttotheaverageproductiscapitals
shareofincome
5pointsforidentifyingtheremainingshareaslaborsshare
b) (10points)Becauseofsubstitutionbiasandtheintroductionofnewandimprovedgoodsand
services,theGDPDeflatorwilltendtounderstatethecostofliving.
ANSWER:False.IfthestatementinsteadreadtheCPIwilltendtooverstatethecost,it
wouldbevalid.
5pointsforcorrectlyidentifyingthatthisisaproblemwiththeCPIbasketnotthedeflator
5pointsforidentifyingthatbecauseoftheseproblems,theCPIoverstatesthecostofliving

c) (10points)IfnominalGDPincreasesby4%,andduringthesameperiod,realGDPincreasesby
1.5%,theninflationmusthavebeenapproximately2.5%.
ANSWER:Thestatementisfairlyaccurate.RecallthatNGDP=PYwherePisthepriceleveland
Yisoutput(realGDP).Usingthelogtimederivativetrick,wecanrearrangethisidentityin
percentagetermstofindthat
%
%
% .Thus,4%1.5%=2.5%,thechangeinthepricelevel(inflation).
5pointsforcorrectrelationshipbetweennominalGDP,realGDP,andthepricelevelineither
levelor%change
5pointsforshowingthatthestatementiscorrect
#1)(40points)Consideracountrywithanaggregateproductiontechnologygivenby
5
2 whereY,KandLareaggregateoutput,capitalandlabor,respectively.
a) (15points)Accordingtotheneoclassicaltheoryofdistributionofincome,whatarethe
equilibriumnominalwagesandnominalrentalratesforlaborandcapital,respectively,ifthe
priceofoutputisequalto$1andtheendowments(supply)ofcapitalandlaborarefixed?
Explain.
ANSWER:Usingthelaborandcapitalmarketequilibriumconditions,
Forthelinearproductiontechnologyabove,MPK=5andMPL=2,sotherealrentalrate
mustbe$5andthewagerate$2.Theequilibriuminthelabormarketscanbedescribed
withaperfectlyelastic(horizontal)demandforinputs(aconstantmarginalproduct)anda
completelyinelastic(vertical)supplyoftheseinputstheflatdemandcurvedetermines
theequilibriumprice.
5pointsforeachcorrectmarginalproduct(10pointstotal)
5pointsforidentifyingthecorrectwageandrentalratethroughtheequilibrium
conditions
b) (10points)Assumingthatthelaborforceisequaltothepopulation,computethepercapita
productionfunction,
whereyandkarepercapitaoutputandcapital,respectively.
Graphtheresultingtechnologywithpercapitaoutputontheverticalaxisandpercapita
capitalstockonthehorizontalaxis.Beprecise.
ANSWER:DividingbothsidesbyL,wecanfindthat
,
Plotshouldconsistofanupwardslopinglinewithaslopeof5andverticalinterceptof2.
5pointsforcorrectpercapitaproductionfunction
5pointsforcorrectdiagramdeductpointsforeachmissingdetail(slopeandintercept)
c) (15points)Ifinstead,thepercapitaproductiontechnologyisgivenby
,
whatrateofgrowthintheequilibriumrealwageisimpliedbytheneoclassicaltheoryifthe
aggregatecapitalstock,K,growsatarateof4%andthepopulation,L,growsatarateof
2%?Explain.
ANSWER:Recallingthatthelabormarketequilibriumimpliesthat,foraCobbDouglas
technology,
.Sincealphaisaconstant,anygrowthinthe
realwagewillbeequaltothegrowthinpercapitaloutputy(recallthaty=Y/Lisalso
averagelaborproductivityorequivalently,theaverageproductoflabor).Thus,weonly
needtocalculatethegrowthrateofythroughthepercapitaproductionfunctiongiven
ourknowledgeoftheaggregatecapitalstocksgrowthandthepopulationgrowthrates.
Takingthenaturallogoftheproductionfunctionyields
Differentiatingtheabovewithrespecttotimeyieldsthegrowthraterelationship
%
Thisisalsotherealwagegrowthrateasarguedaboveearlier.
10pointsforrecognizingthatthegrowthintheequilibriumrealwageisequaltothe
growthintheaverageproductoflabor.
5pointsforcorrectlycomputingthegrowthrateinoutputpercapita
#2)(30points)Inthecontextoftheloanablefundsmodel,
a) (10points)Explainthecircumstancesunderwhichaninvestmenttaxcredit(ITC)would
increasetheequilibriumquantitiesofsavingsandinvestment?Beasspecificaspossible.
ANSWER:Aninvestmenttaxcredit(ITC),whichcausesanincreaseindemandfor
investmentatanyleveloftherealinterestrate(bymakingitcheapertoundertakean
entrepreneurialendeavor),willonlyincreasetheequilibriumquantitiesofsavingsand
investmentifthesupplycurveforloanablefunds(nationalsavings)isupwardsloping
(dependspositivelyontherealinterestrate).Sinceoutputisfixedintheloanablefunds
modelandgovernmentpurchasesistakentobeexogenous,savingswillonlydepend
positivelyontherealinterestrateifconsumptiondependednegativelyonthereal
interestrate(sincesavingsisinverselyrelatedtoconsumption).
5pointsforsayingthatsavingsmustslopeupwards
5pointsforsayingthatthisonlyhappensifconsumptionisinverselyrelatedtothereal
interestrate
b) (10points)Explainhowchangingbudgetdeficitsmightaffectthequantityofloansissuedto
entrepreneurs.Considerallcasesofhowthebudgetdeficitmaychange.
ANSWER:Increasingabudgetdeficit(byincreasingG,decreasingT,orboth)causesa
reductionofnationalsavingsandupwardpressureontherealinterestrate,crowdingout
investmentbymakingloansmoreexpensiveforentrepreneurs.Reducingthebudget
deficit(bydecreasingG,increasingT,orboth),ontheotherhand,cancauseanincreasein
nationalsavingsanddownwardpressureontherealinterestrate,makingloanscheaper
forentrepreneurs.
5pointsforcorrecteffectsontheinterestrate
5pointsforcorrecteffectsonquantityofloans
c) (10points)Arguethatifthequantityofsavingsexceedsthequantityofinvestmentatthe
currentrealinterestrate,thenitmustalsobethecasethatthereisasurplusinthemarket
forgoodsandservicesandweshouldexpecttherealinterestratetofallinordertorestore
equilibrium.(hint:adiagramoftheloanablefundsmodelalongwiththemarketclearing
conditionshouldhelp)
ANSWER:ifS>I,thenitmustbethecasethatr>r*sothatrneedstofalltorestore
equilibrium.Notealso,thatS>IimpliesYCG>IwhichimpliesY>C+G+I,sothatsupply
exceedsdemandthatis,whenthereisasurplusinthemarketforloans,thereisa
surplusinthemarketforgoodsandservices.
5pointsthatrmustfalltorestoreequilibrium
5pointsforidentifyingthatS>IimpliesY>C+I+Gorstatingtheequivalentwithwritten
argument

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ECON 110A Midterm Exam 1B
Name________________________
Prof. Levkoff
PID #_________________________
Fall Quarter 2014
Seat #________________________
a) (10points)IfnominalGDPincreasesby4.5%,andduringthesameperiod,realGDPincreases
by2%,theninflationmusthavebeenapproximately2.5%.
ANSWER:Thestatementisfairlyaccurate.RecallthatNGDP=PYwherePisthepriceleveland
Yisoutput(realGDP).Usingthelogtimederivativetrick,wecanrearrangethisidentityin
percentagetermstofindthat
%
%
% .Thus,4.5%2%=2.5%,thechangeinthepricelevel(inflation).
5pointsforcorrectrelationshipbetweennominalGDP,realGDP,andthepricelevelineither
levelor%change
5pointsforshowingthatthestatementiscorrect
b) (10points)Becauseofsubstitutionbiasandtheintroductionofnewandimprovedgoodsand
services,theGDPDeflatorwilltendtounderstatethecostofliving.
ANSWER:False.IfthestatementinsteadreadtheCPIwilltendtooverstatethecost,it
wouldbevalid.
5pointsforcorrectlyidentifyingthatthisisaproblemwiththeCPIbasketnotthedeflator
5pointsforidentifyingthatbecauseoftheseproblems,theCPIoverstatesthecostofliving
c) (10points)ConsideracountrythatproducesoutputusingonlycapitalandlaborwithaCobb
Douglastechnology.Ifthemarginalproductoflaboris7andtheaverageproductoflaboris10,
thencapitalssharemakesup30%ofthetotalnationalincome.Assumethatthelaborand
capitalmarketsareinequilibrium.
ANSWER:RecallthatforaCobbDouglastechnology,
capitalsshareofincome.Substitutingtheinformationgiven,itmustbethecasethat
%.Thisimpliesthatcapitalsshareofnationalincomeisequalto30%as
statedaccuratelyabove.
5pointsforrecallingthattheratioofthemarginalproducttotheaverageproductislabors
shareofincome
5pointsforidentifyingtheremainingshareascapitalsshare
#1)(30points)Inthecontextoftheloanablefundsmodel,
a) (10points)Explainthecircumstancesunderwhichacostsaving,technological
advancementwouldincreasetheequilibriumquantitiesofsavingsandinvestment?Beas
specificaspossible.
ANSWER:Acostsavingtechnologicaladvancement,whichcausesanincreaseindemand
forinvestmentatanyleveloftherealinterestrate(bymakingitcheapertoundertakean
entrepreneurialendeavor),willonlyincreasetheequilibriumquantitiesofsavingsand
investmentifthesupplycurveforloanablefunds(nationalsavings)isupwardsloping
(dependspositivelyontherealinterestrate).Sinceoutputisfixedintheloanablefunds
modelandgovernmentpurchasesistakentobeexogenous,savingswillonlydepend
positivelyontherealinterestrateifconsumptiondependednegativelyonthereal
interestrate(sincesavingsisinverselyrelatedtoconsumption).
5pointsforsayingthatsavingsmustslopeupwards
5pointsforsayingthatthisonlyhappensifconsumptionisinverselyrelatedtothereal
interestrate
3

b) (10points)Explainhowchangingbudgetdeficitsmightaffectthequantityofloansissued
toentrepreneurs.Considerallcasesofhowthebudgetdeficitmaychange.
ANSWER:Increasingabudgetdeficit(byincreasingG,decreasingT,orboth)causesa
reductionofnationalsavingsandupwardpressureontherealinterestrate,crowdingout
investmentbymakingloansmoreexpensiveforentrepreneurs.Reducingthebudget
deficit(bydecreasingG,increasingT,orboth),ontheotherhand,cancauseanincreasein
nationalsavingsanddownwardpressureontherealinterestrate,makingloanscheaper
forentrepreneurs.
5pointsforcorrecteffectsontheinterestrate
5pointsforcorrecteffectsonquantityofloans
c) (10points)Arguethatifthequantityofinvestmentexceedsthequantityofsavingsatthe
currentrealinterestrate,thenitmustalsobethecasethatthereisashortageinthemarket
forgoodsandservicesandweshouldexpecttherealinterestratetoriseinordertorestore
equilibrium.(hint:adiagramoftheloanablefundsmodelalongwiththemarketclearing
conditionshouldhelp)
ANSWER:ifS<I,thenitmustbethecasethatr<r*sothatrneedstofalltorestore
equilibrium.Notealso,thatS<IimpliesYCG<IwhichimpliesY<C+G+I,sothatsupply
exceedsdemandthatis,whenthereisasurplusinthemarketforloans,thereisa
surplusinthemarketforgoodsandservices.
5pointsthatrmustrisetorestoreequilibrium
5pointsforidentifyingthatS<IimpliesY<C+I+Gorstatingtheequivalentwithwritten
argument
#2)(40points)Consideracountrywithanaggregateproductiontechnologygivenby
3
6 ,whereY,KandLareaggregateoutput,capitalandlabor,respectively.
a) (15points)Accordingtotheneoclassicaltheoryofdistributionofincome,whatarethe
equilibriumnominalwagesandnominalrentalratesforlaborandcapital,respectively,ifthe
priceofoutputisequalto$1andtheendowments(supply)ofcapitalandlaborarefixed?
Explain.
ANSWER:Usingthelaborandcapitalmarketequilibriumconditions,
Forthelinearproductiontechnologyabove,MPK=3andMPL=6,sotherealrentalrate
mustbe$3andthewagerate$6.Theequilibriuminthelabormarketscanbedescribed
withaperfectlyelastic(horizontal)demandforinputs(aconstantmarginalproduct)anda
completelyinelastic(vertical)supplyoftheseinputstheflatdemandcurvedetermines
theequilibriumprice.
5pointsforeachcorrectmarginalproduct(10pointstotal)
5pointsforidentifyingthecorrectwageandrentalratethroughtheequilibrium
conditions
b) (10points)Assumingthatthelaborforceisequaltothepopulation,computetheper
capitaproductionfunction,
whereyandkarepercapitaoutputandcapital,
respectively.Graphtheresultingtechnologywithpercapitaoutputontheverticalaxisand
percapitacapitalstockonthehorizontalaxis.Beprecise.
ANSWER:DividingbothsidesbyL,wecanfindthat
,
Plotshouldconsistofanupwardslopinglinewithaslopeof3andverticalinterceptof6.
5pointsforcorrectpercapitaproductionfunction
5pointsforcorrectdiagramdeductpointsforeachmissingdetail(slopeandintercept)
c) (15points)Ifinstead,thepercapitaproductiontechnologyisgivenby
,
whatrateofgrowthintheequilibriumrealwageisimpliedbytheneoclassicaltheoryifthe
aggregatecapitalstock,K,growsatarateof5%andthepopulation,L,growsatarateof
1%?Explain.
ANSWER:Recallingthatthelabormarketequilibriumimpliesthat,foraCobbDouglas
technology,
.Sincealphaisaconstant,anygrowthinthe
realwagewillbeequaltothegrowthinpercapitaloutputy(recallthaty=Y/Lisalso
averagelaborproductivityorequivalently,theaverageproductoflabor).Thus,weonly
needtocalculatethegrowthrateofythroughthepercapitaproductionfunctiongiven
ourknowledgeoftheaggregatecapitalstocksgrowthandthepopulationgrowthrates.
Takingthenaturallogoftheproductionfunctionyields
Differentiatingtheabovewithrespecttotimeyieldsthegrowthraterelationship
%
Thisisalsotherealwagegrowthrateasarguedaboveearlier.
10pointsforrecognizingthatthegrowthintheequilibriumrealwageisequaltothe
growthintheaverageproductoflabor.
5pointsforcorrectlycomputingthegrowthrateinoutputpercapita
SCRATCHPAPER
(DONOTDETATCH)
SCORINGRUBRIC
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ECON 110A Final Exam
Name________________________
Prof. Levkoff
PID #_________________________
Summer Session I 2015
Seat #________________________
a) (7points)Thebathtubmodelofunemploymentwillpredictalongrunsteadystaterate
ofunemploymentequalto10%iftherateofjobseparationis5%andtherateofjob
findingis20%.
ANSWER:Recall,thatinthebathtubmodelofunemployment,thesteadystaterate
wasgivenby
%
%
%
%
Thus,thestatementisnotvalidsincethebathtubmodelispredictingarateof20%
unemployment.
b) (7points)Theloanablefundsmodelpredictsthatrunningagovernmentbudgetdeficit
orissuinganinvestmenttaxcredittoentrepreneurswillbothhavethesameeffectson
therealinterestrateandoninvestment.
ANSWER:Whileeachpolicydoeshavesimilareffectsontherealinterestrate(they
bothdriveitup),theformerpolicy(runningabudgetdeficit)willcauseinvestmentto
fallwhereastheinvestmenttaxcreditwillcauseinvestmenttostaythesameorrise
(dependingonwhetherornotthesavings/supplyfunctionslopesupwardoris
perfectinelastic).Thus,thestatementisonlypartiallyvalidregardingtheeffectson
interestrates.However,theeffectsoninvestmentarenotthesame.

c) (7points)IftheproductionfunctioninthebaselineSolowmodelwasalteredsothatit
exhibitedincreasingmarginalproductivityofcapitalpercapita,thenthemodelwill
exhibittwostablesteadystates.
ANSWER:Thisisthecase.RecallthattheproductionfunctionforthebaselineSolow
modelwasgivenby
.InordertohaveincreasingMPk,weneed
.If
thatisthecase,thenwecanidentifythesteadystatesgraphicallybelowforthe
baselinemodel:
Thus,thereisonestablesteadystateatk=0(theusualdegeneratesolution)aswellas
anotherunstablesteadystateatk*>0.
d) (7points)TheykeyexplanationusedbyRomertolegitimizetheuseoftheassumption
ofanincreasingreturnstoscaletechnologyinvolvedarguingthatbluecollarfactory
workerswhogostraightintoindustryhaveuniqueskillsetsthatincreaseproductivityby
afactormuchgreaterthantheirowneffort.
ANSWER:Thisisnotthecase.Romerlegitimizedtheuseofincreasingreturnsby
arguingthatthesourceofthereturnscomesfromknowledgebeingusedasanon
rivalinputintheproductionprocess.
PartII:Analysis/Problems(72points)
variableshavea
, .
, .
.
,
Explain.
rate
,
sothatanincrease
effects?
4
, ,and exhibitgrowtheffects. onlyexhibitsaleveleffecton . and

alsoexhibitsaleveleffecton (sothesevariablesexhibitsbothagrowthand
leveleffectsinthisvariationofthemodel).
%
2pointsifthemissthebutdoattempttodothegrowthaccountingabove
1pointiftheymissthebecausetheyforgettodothegrowthaccountingabove
changes/additions:
/
,

.
alsobeconstant.
Nopartialcredit
must
e) (6points)Useyouranswersfroma)d)tofindanexpressionforoutputpercapitaas
afunctionofalloftheexogenousmodelparameters, ,andtime,t,inthe
theBGP
f)
technology,
%
sothatthe
Sothat
#2)(20points)Consideraneconomyinthelongrunwherethevelocityofmoneyisconstant,
themoneysupplygrowsat5%peryear,andrealoutputgrowsat2%peryear.
a) (4points)Iftherealinterestrateis3%,thenapproximately,whatmustthenominal
interestratebe?
ANSWER:Wearegiventhat%
%,%
%,and%
.Usingthe
quantitytheoryequation,thesevalueswillletussolvefortheinflationratesince
%
%
%
%
Where% istheinflationrate, .Substitutingvaluesandsolvingforthe
inflationrate,wefindthatitmustbe3%.
Usingthefisherequation,thenominalratemustbeapproximatelyequaltothe
realrateplusinflation,whichis6%.
b) (8points)Nowsupposethat,becauseofimprovedaccesstobankingtechnologies,
peopleintheeconomybegintoholdfewerdollarsasmoneyperdollarofincome.
Specifically,supposethatthefractionofincomeheldasmoneyfallsby7%.What
effectwillthishaveonvelocity(beasspecificasyoucan)?
ANSWER:Recallthatifnominalmoneydemandisexpressedasaconstant
fractionofincomeby
,thentheequilibriuminthemoneymarket
impliesthatvelocityandtheparameterkmustberelatedby
(
sothat%
% .Thus,a7%reductioninkcorrespondstoapproximatelya
7%increaseinvelocityV.
c) (8points)Ifthevelocityinsteadgrowsatarateof1%,whatshouldthecentralbank
doifitwishestokeepthelongrunnominalinterestratefromchanginginresponse
tothetechnologicalshockinb)(beasspecificaspossible)?
ANSWER:
Recallinparta),thenominalinterestratewas6%.Sincethevelocityhas
increasedby1%,thiswouldpushinflation(andhencenominalinterestrates,
throughtheFishereffect)upwardsbythesameamount.Thus,inordertokeep
thenominalinterestratefromchanging(regardlessofthereferencevalue),we
wouldneedtoreducethemoneysupplygrowthratebyanequalamountby1%.
#3)(20points)Consideranindividualthatlivesforonlytwoperiods,0and1.Theconsumer,as
arational,forwardlookingindividual,wantstomaximizethesubjectivelydiscountedlifetime
Theinstantaneousutility(presentvalue)inagivenperiodisgivenbythe
function

Theconsumerisexogenouslyendowedwith unitsofcapitalwhichhecanuse
where
togenerateincomeusingthetechnologygivenby
istheusualtotalfactorproductivityparameterandisexogenous.
Theonlywayaconsumercanbringresourcestothefutureistosavesome
outputfromthepreviousperiod,effectivelyturningtheoutputinto
Therateofcapitaldepreciationisalsoexogenousandgivenby .
periodusingtheparametervaluesprovidedaboveandshowthattheresource
constraintforperiodzeroisidenticaltothelawofmotioninthebaselineSolow
model.
ANSWER:
Period0:
Period1:
10
Usingtheperiodzeroresourceconstraint,wecansolvefor

identicaltothelawofmotionforthebaselineSolowmodel.
Fortheremainderoftheproblem,assumecapitalfullydepreciatesafteruseeachperiodsothat
1.
b) (4points)Writeouttheagentsintertemporalutilitymaximizationproblemasa
functionofonlyperiod1capital, ,usingyourconstraintsfroma)
ANSWER:Theagentsolves:
,
,
subjecttotheconstraintsina).Substitutingtheconstraintsina)forthevaluesof
consumptionyieldstheoptimizationproblemasafunctionofonlyonechoice
variable, .
c) (4points)Derivethefirstorderconditionwithrespecttocapital, ,andinterpret
yourresults.Atwhatratedoesconsumptiongrowovertimeaccordingtothe
optimalsolution?
ANSWER:Differentiatingwithrespectto andsettingthefirstordercondition
equaltozeroimpliesthefollowingrelationship,whichequatesthemarginalutility
offoregoneconsumptiontodaywiththegaininfuturemarginalutilitytheEuler
equation:
11
Whichimpliesthat
Whichisequivalentto

thisistheEulersConsumption
Equation.
d) (6points)Computetheoptimalvaluesof ,
(andconstants).
PROBLEMREMOVED
12
asfunctionsofonly
, and
SCRATCHPAPER
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14
d)
/6
ECON 110A Midterm Exam Solutions
Name________________________
Prof. Levkoff
PID #_________________________
Summer Session I 2015
Seat #________________________
a) (10points)ForatechnologydescribedbytheCobbDouglasproductionfunctionwithconstant
sharesofincomepaidtoinputs,thegrowthrateofthemarginalproductofaninputovertime
mustbeequaltothegrowthrateoftheaverageproductofthatinput.
SUGGESTEDANSWER:Thisisfairlyaccurate.Ifthereareconstantsharesofincomepaidto
inputs,thismeansthattheexponentsintheCobbDouglasfunctionarenotchangingover
time.Withoutlossofgenerality,considerthemarginalproductoflaborforthecase
:
Takingthelogdifferencetreating
asaconstantyields
%
%
.
Fullcreditforthecompleteproof.
Assignpartialcredit(nomorethan7points)asneededforanswersthatdonthaveallofthe
correctelements.Creditshouldbeawardedfortheexplanation(andnotjustforsayingTrue
orFalse).
b) (10points)Theloanablefundsmodelpredictsthatgovernmentspendingandinterestratesare
positivelycorrelated,ceterisparibus.
SUGGESTEDANSWER:Thisisalsofairlyaccurate.Intheloanablefunds(neoclassicalmodel),
anincreaseingovernmentspending,allotherfactorsheldconstant,willresultinareduction
ofnationalsavings(shiftssavingstotheleft),pushingtheinterestrateup.Thus,whenG
increases,sodidr,implyingthatthemodelpredictsapositivecorrelationbetweenthese
variables.
Fullcreditfortheanswerprovidedaboveevenifgraphicallyillustrated(infact,drawinga
pictureshouldalmostbeabetterexplanationthanthemexplainingwithwrittenargument
only).
Nomorethan7pointsiftheysayfalseandprovideanincorrectexplanation(likesayingthat
theincreaseinGcausesrtodroporgetthemechanismwrong).
c) (10points)OnereasonwhytheCPImayoverstatethecostoflivingforhouseholdsisbecauseit
includesspendingoncapitalgoodslikeindustrialequipment,whichhouseholdstypicallydont
purchase.
SUGGESTEDANSWER:Thisisnotthecase.Thestatementiswrongforafewreasons:
First,theCPItypicallyoverstatesthecostoflivingtohouseholdsduetothesubstitutionbias,
thelackofinclusionofnewgoodsinthebasket,andtheinabilitytoaccountforquality
improvementsovertime.
Thesecondwaytofixthestatementwouldbetoidentifythat,ifinsteadofCPI,thestem
hadreadGDPdeflator,thestatementwouldbemoreaccuratebecausetheDeflator
includesinvestment/capitalgoodsthatwouldnotshowupinaconsumerbasket,upward
biasingtheconsumerscostofliving.
Fullcreditforidentifyingbothsidesoftheargument
7pointsforonlyonesideoftheargument
DeductapointiftheycantmentionwhytheCPIbiasesthemeasureupwards(all3reasons)IF
theyprovidedthissolutionORIFtheydontmentionexplicitlythatthedeflatorincludes
capitalgoodsifthatsolutionisprovided(orboth)

#1)(30points)Consideranaggregateproductiontechnologythatusescapital,labor,andenergygiven
/
/
/
,whereY,K,L,andEareaggregateoutput,capital,labor,andenergy,
by
, ,
respectively.
a) (10points)Forthispartonly,assumethatE=1.Then,accordingtotheneoclassicaltheory
ofdistributionofincome,whataretheequilibriumnominalwagesandnominalrentalrates
forlaborandcapital,respectively,ifthepriceofoutputisequalto$1andtheendowments
(supply)ofcapitalandlaborarefixedat
and
?Explain.
ANSWER:Inequilibrium,therealandnominalinputpriceswillequalthemarginal
productsoftherespectiveinputs.Sincethepriceofoutputis$1,thisboilsdowntothe
nominalrentalrateandnominalwageequalingthemarginalproducts:
5pointsforeachcorrectexpressionintermsoftheendowmentsofcapitalandlabor.
b) (10points)Iflabor,capital,andenergyutilizationaregrowingovertimeandnolongerfixed
withthelaborutilizationgrowingatarateof3%,capitalutilizationgrowingatarateof4%,
andenergyutilizationgrowingat5%,bywhatratedoesaggregateoutputgrowforthis
technology?
ANSWER:Usingthelogdifferenceapproachwiththeproductionfunction,wecan
transformitintogrowthratessuchthat:
%
Fullcreditfortheanswerprovided.Deductonly3pointsifstudentsmakeamathematical
error(say,substitutingthewrong%inORforgettousethelogpropertycorrectly)but
carryitthroughmostlycorrectinawaythatdemonstratesthattheyatleastknewhowto
approachtheproblem.
c) (10points)Provethatthisproductiontechnologyexhibitsconstantreturnstoscalewith
respecttoallofitsinputsandderivethepercapitaversionoftheproductionfunction,
, ,wherethelowercasevariablescorrespondtotheiruppercasecounterpartsdivided
byL.
ANSWER:WecanprovethattheproductionfunctionisCRSbydoublingalloftheinputs
andobservingwhathappenstooutput:
, ,
, ,
Thus,wehaveaCRStechnologyanditispossibleforustorewriteitintermsofallofthe
percapitavariables,soletsgoaheadanddoexactlythat:
5pointsfortheproof(simplystatingthattheexponentssumto1isntreallyaproof,so
deduct2pointsiftheydothissincethequestionstemasksthemtoprove).
5pointsforshowingthenewproductionfunction(deduct2pointsiftheydidntshow
theirworksincethequestionaskstoderive,notstate).

/
#2)(15points)Thephenomenainthediagrambelowisrelatedtotheproductionmodel
where
yisGDPpercapitaandkisthecapitalstockpercapita.AllvaluesarerelativetotheUnitedStates,which
isnormalizedto1.Thesolidlineisthe45degreelinethroughtheorigin(theaxesareshifted).
UsingthetermsCobbDouglas,constantreturnstoscale,capitalsshareofincome,andtotalfactor
productivity,explainthephenomenaintheabovediagram.Besuretoexplaintheunderlying
assumptionsthatareresponsiblefortheresultandtheimplicationsforhowthemodelcanbe
improved.
SUGGESTEDANSWER:ThediagramaboveshowsthefitoftheproductionmodelfortheCobb
Douglasproductionmodelwithconstantreturnstoscaleforthecasewhereitisassumedthat
capitalsshareofincomeis1/3andtotalfactorproductivityisthesame(normalizedto1,theUS
value)forallcountries.Thismodeloverpredictsthelevelofincomepercapitabasedoncapital
accumulationaloneundertheassumptionthatallcountrieshaveTFPidenticaltotheUS.Weareable
toimprovethefitofthismodel(sothatitfitsperfectly)byallowingtotalfactorproductivitytobe
differentforeachcountrybyfittingtheimpliedTFPparameterbysolving
fortheparameter
Awherethevalueswiththehatsareactualvaluesobservedinthedata.Ifcountrieshavediffering
factorproductivities,thenitisasifeachcountryhasadifferingleveloftechnologyandusesitsown
productionfunctionasopposedtoallcountriesusingthesameproductionfunction.
2pointsforusingeachtermcorrectly(8total)
3pointsforexplainingthatthemodeloverpredictsGDPpercapitaundertheassumptionsof
homogenousTFP.
4pointsformentioninghowtoimprovethefitofthemodel
#3)(25points)ConsiderthebaselineSolowgrowthmodelwithtechnologygivenby
,where
yandkareincomeandcapitalpercapita.Thedepreciationrateis25%andthesavingsrateis50%.
Thereisnopopulationgrowthortechnologicalprogress.
a) (5points)Writedownthelawofmotionforthecapitalstockbyexpressing asa
functionofk.
ANSWER:
Nopartialcredithere.Deduct1pointiftheydontusethevaluesprovided.
b) (10points)Computethesteadystatevalueofthecapitalstock.
ANSWER:Setting
yieldsthesteadystatevalueofcapitalgivenby
(thereisalsoadegeneratesteadystateatzerolikeusual).
Fullcreditforthecorrectanswerof1
Deduct2pointiftheycorrectlyappliedthesteadystatetoanincorrectlawofmotion
froma)
Provideonly5pointsiftheyidentifythedegeneratesteadystateat0.
c) (10points)Basedonthesteadystatethatyoufoundinb),shouldthecountryincrease
ordecreasethesavingsratetomoveitselftowardstheGoldenRulelevelofcapitalifit
wantedtomaximizetheconsumptionprofileinthesteadystate?Explain.
ANSWER:Weneedtocheckonwhetherornotthecondition
holds,since
thisistheconditionconsistentwiththegoldenrule.Ifitdoesnthold,thenwecan
figureoutwhichsideofthegoldenrulekwearecurrentlyoperatingon:
.
inthesteadystate.Thevalueofdepreciationis25%,whichislessthantheMPk.
Thus,wemustbetotheleftofthegoldenrule,meaningthatweneedtoincreasethe
savingsratetomoveustoahigherlevelofconsumptioninthesteadystate.
5pointsforcorrectlycomparingMPktodepreciation
5pointsforcorrectconclusiongiventhetest(eveniftheyusedthedegeneratesteady
stateinthepreviouspartgivethemcreditiftheyappliedthistestcorrectlyinfull).
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ECON 110A Final Exam A Solutions

Fall Quarter 2014

in , ,or wouldincreasethegrowthrateof .Increasesintheinitialstockof

, ,and exhibitgrowtheffects. onlyexhibitsaleveleffecton . also

ECON 110A Final Exam B Solutions

Fall Quarter 2014

in , ,or wouldincreasethegrowthrateof .Increasesintheinitialstockof

, ,and exhibitgrowtheffects. onlyexhibitsaleveleffecton . also

ECON 110A Midterm Exam 2A Solutions

Fall Quarter 2014

ECON 110A Midterm Exam 2B Solutions

Fall Quarter 2014

c) (7points)Computethesteadystatevalues , , and usingyouranswerfrom

ECON 110A Midterm Exam 1A Solutions

Fall Quarter 2014

ECON 110A Midterm Exam 1B

Fall Quarter 2014

ECON 110A Final Exam

Summer Session I 2015

, ,and exhibitgrowtheffects. onlyexhibitsaleveleffecton . and

ECON 110A Midterm Exam Solutions

Summer Session I 2015

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