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uman "apital Heres a production function with a slight twist from the book - consider a Cobb-Douglas production function with three inputs. K is capital (the number of machines), L is labor (the number of workers), and H is human capital (the number of college degrees among the workers). The production function is
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Problem Set 4 FE411 Spring 2008 Rahman e# *ome people ad$ocate go$ernment funding of college scholarships as a wa) of creating a more egalitarian societ). /thers argue that scholarships help onl) those who are able to go to college. Do )our answers to the preceding 0uestions shed light on this debate& I) more colle+e scholarships increase H then it !oes lea! to a more e+alitarian societ#. ,he polic# lowers the returns to e!ucation !ecreasin+ the +ap *etween the wa+es o) more an! less e!ucate! wor%ers. More importantl# the polic# e"en raises the a*solute wa+e o) uns%ille! wor%ers *ecause their mar+inal pro!uct rises when the num*er o) s%ille! wor%ers rises. 2) $he Solow %rowth &odel with %rowing E''i ien ( o' )abor 1ssume that production is a function of capital and e))ecti"e labor, and that the rate of sa$ings, depreciation, population growth, and labor-augmenting technological progress are all constant, as described in Chapter 2s $ersion of the *olow 3odel. 4urther, assume that the production per effecti$e worker can be described b) the function
# = ) (% ) = %
where % is capital per effecti$e worker.
(# ) 5
a. +sing the functional form for #, write the functions for both consumption and in$estment in the *olow 3odel. i = s%-.. c = &1-s(%-.. b# 'rite the 6aw of 3otion of Capital (using the functional form for #). 'hat condition for the 6aw of 3otion of Capital must hold for the econom) to be in a stead) state& *how the stead) state condition on a graph with the in$estment function and the depreciation of capital per effecti$e worker. /% = s%-.. 0 &1'n'+(% 2or stea!# state this e3pression must e4ual 5ero. 67raph not shown see *oo% 8 notes9.
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# *ol$e for the stead)-state $alue of # as a function of s, n, +, and 1. s%*-.. = &1'n'+(%*. :ol"in+ )or %* +i"es us %* = &s/& 1'n'+((2. Plu++in+ this into our pro!uction )unction +i"es us; #* = s"&n'1'+(
d# 1 de$eloped countr) has a sa$ing rate of 527 and a population growth rate of #7 per )ear. 1 less-de$eloped countr) has a sa$ing rate of #87 and a population growth rate of 97 per )ear. (n both countries, + : 8.85 and 1 : 8.89. 4ind the stead)-state $alue of # for each countr). Plu+ into e4uation a*o"e. <e"elope! countr#; #* = = <e"elopin+ countr#; #* = 1 e# 'hat policies might the less-de$eloped countr) pursue to raise its le$el of income& In!uce sa"in+s; ta3 incenti"es *alancin+ *u!+et etc. In!uce re!uction in population +rowth; e3plicit laws ta3 incenti"es etc. '# ,%plain wh) the sa$ings rate in an econom) is so important for the stead) state. (f the less-de$eloped countr) increases its sa$ings rate, show on the graph from b what happens to the in$estment function and the stead) state le$el of capital. 'hat is the cost toda) of increasing the sa$ings rate& 'hat are the benefits of doing so& :a"in+s translates into permanent increases o) li"in+ stan!ar!s throu+h raisin+ capital stoc%s per person. >n the +raph 6not shown9 #ou woul! !raw a new in"estment line an! illustrate a hi+her %* an! #*. ,he cost o) raisin+ s is a lower consumption per person to!a#. ,he *ene)its come in the )orm o) hi+her output per person. $hether or not this also translates into hi+her lon+-run consumption per person is uncertain. g# 'rite the ;olden <ule for ma%imi=ing consumption. +se the ;olden <ule to sol$e for the ;olden le$el of stead) state %, #, c, and i.
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Problem Set 4 FE411 Spring 2008 Rahman ,he 7ol!en ?ule in this pro*lem is where MPK = n ' 1 ' +. @sin+ our )unctional )orm this means that MPK = -..%*--.. = n ' 1 ' +. :ol"in+ )or this capital per person le"el we )in! that; %*&+.r.( = &-../&n'1'+((2. ,his means that #*&+.r.( = &-../&n'1'+((. c*&+.r.( = &1-s(&-../&n'1'+((. i &+.r.( = s&-../&n'1'+((.
*
Aotice that the +ol!en rule income le"el is &-../&n'1'+(( while our 7BAB?CL pro!uction )unction in stea!# state is s"&n'1'+( &)rom part c(. :o how )ar is each countr# )rom the +ol!en rule le"el o) output pro!uctionD 2or the !e"elope! countr# with s = -.2E it is pro!ucin+ onl# -.2E/-.. = .FG as much as it shoul! *e i) it were attemptin+ to ma3imi5e lon+-run consumption. 2or the !e"elopin+ countr# with onl# s = -.1 it is e"en worseH it is pro!ucin+ -.1/-.. = 2-G as much as it shoul! *e i) it were attemptin+ to ma3imi5e lon+-run consumption. ,he *ottom line is it appears that each countr# is short-chan+in+ the )utureI 7ettin+ to the +ol!en rule le"el woul! clearl# re4uire sa"in+ .-G o) income an! thatJs a lot.
*) Predi tions o' the Real E onom( 'rom Solow -ro$e each of the following statements about the stead) state with population growth and technological progress. (>ote ?ou need to understand section 2-# fairl) thoroughl) for this one. >ote also that these are not $er) rigorous proofs @ )ou Aust need a bit of deducti$e logic). a# The capital-output ratio is constant. In stea!# state s# = &1'n'+(%. ,his means that %/# = s/&1'n'+( which is a constant. b# Capital and labor each earn a constant share of an econom)s income BHint <ecall the definition of 3-CD. KapitalJs share o) income is MPK*&K/Y(. 2rom part a we %now that K/Y is constant. 2urther +i"en that % is constant in stea!# state its mar+inal pro!ucti"it# must *e constant as well.
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Problem Set 4 FE411 Spring 2008 Rahman # The real rental price of capital is constant, and the real wage grows at the rate of technological progress +. BHint The real rental price of capital e0uals total capital income di$ided b) the capital stock, and the real wage e0uals total labor income di$ided b) the labor force.D ,he real rental price o) capital ? = ,otal Kapital Income/Kapital :toc% = &MPK*K(/K = MPK. ,his we %now is constant so the real rental price o) capital is constant. ,he real wa+e is w = ,otal La*or Income/La*or 2orce ,his means that w*L = ,otal La*or Income &,2I( Kon"ertin+ to rates o) chan+e; /w/w '/L/L = /,LI/,LI $e %now that the la*or )orce +rows at rate n an! that total la*or income +rows at rate n'+. ,hus real wa+es +row at rate +. Kool huhD $ell I thin% so an#wa#L
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