Assignment # 1 ECON302 Macroeconomic Theory 2 Department of Economics University of Waterloo Winter 2009 Instructor: Derek Pyne Due date:

Section 1: Tuesday, October 13, 2009 Section 2: Wednesday, October 14, 2009

General Instructions 1. Assignments are due by the beginning of class on the due date. 2. Note, after I collect the assignments in class for section 2, I will make the solution outlines available to the entire class. Therefore, it will be IMPOSSIBLE for me to accept any late assignments after that time from students in either section. Any assignments received after that time will receive a mark of zero. 3. Please to not email me scanned copies of your assignment. They take up a lot of room on the university server. If you absolutely cannot be on campus to give me the assignment in person, you can fax it to the department. However, make absolutely sure you allow enough time for the administrative staff to put the assignment in my mailbox before class so I know it was handed in on time. It is best to just hand in assignments in person. 4. Depending on how fast class proceeds, you may have to read ahead to answer some of the questions. 5. Show and explain all your work! Few, if any, marks will be given for lucky guesses. 6. Although you are encouraged to share ideas, insights, etc. when working on your assignments, what you hand in must be your own individual work! 7. To make it easier to return these assignments in class, while at the same time following the universitys privacy policy, you should not put both your name and student number on the first page. Please put your name on the first page but your student number on the second page. That way, other students will not see your student number if I let them search through a pile of assignments to find their own. 8. Please put your section number on the cover of the assignment you hand in. 9. Answer all questions. Questions 1. Assume a production function of the form F(K, L) = Y = 10K1/4L3/4. (a) (5 Marks) Determine the degree of homogeneity of this production function. (b) (5 Marks) Assume 2% of the capital stock wears out in any given years. Further assume that there is no population growth or technological progress. Find the Golden Rule level of capital stock per worker. (c) (7 Marks) Given your answer in (b), find the level of output per worker, the amount of depreciation per worker, the level of gross investment per worker, the rate of gross savings per worker, and the level of consumption per worker in the steady state.

2 (d) (7 Marks) Now assume that instead of being at the Golden Rule level, the gross savings rate s = 0.128. Recall that gross savings gives the rate of savings out of gross income and not net income. Find the steady state level of capital per worker, output per worker, consumption per worker, savings and investment per worker, and depreciation per worker. 2. Suppose output is produced according to the production function Y = K[(1u)L]1, where K is capital, L is labour and u is the natural rate of unemployment. The gross savings rate is s and capital depreciates at rate . Assume population grows at rate n but there is no technological change (g = 0) (a) (15 Marks) Express output per worker (y = Y/L) as a function of capital per worker (k = K/L) and the natural rate of unemployment. Describe the steady state of this economy. (b) (10 Marks) Suppose that some change in government policy reduces the natural rate of unemployment. Describe how this change affects output both immediately and over time. Is the steady-state effect on output larger or smaller than the immediate effect? 3. Assume a country's production function is Y = AK03L07. The ratio of capital to output is 3, the rate of technological growth is 3 percent, and the depreciation rate is 4 percent. There is no population growth. Capital is paid its marginal product. (a) (8 Marks) What is the marginal product of capital in this situation? (b) (5 Marks) If the economy is in a steady state, what must be the gross saving rate? (c) (5 Marks) If the economy decides to achieve the Golden Rule level of capital and actually reaches it, what will be the marginal product of capital? (d) (8Marks) What must the gross saving rate be to achieve the Golden Rule level of capital? 4. (25 Marks) Please answer question 7 on page 66 of your textbook.