1

ECN 312 Intermediate Macroeconomics

Spring 2017

Problem Set 1

Due on Wednesday, March 22nd in class

You are strongly encouraged to work in groups, but you must turn in your own an-
swers, in your own words, and indicate on the first page of your solution the names of
any students you have worked with.

1. (To make sure that you read Ch.2 and Ch.3 of Jones) Ex.2.2, Ex.2.5, and Ex.3.10

2. (Optimal Savings Rate or Golden Rule Savings Rate, based on Ex. 2.5 in Jones and
Vollarth1 ) Answer the following questions in the context of the Solow model with no
technological progress.

(a) Consumption is equal to output minus investment: c = (1 s)y. What is the

savings rate that maximizes steady-state consumption per worker?

(b) Assuming that capital income share is roughly 0.35, comment on the level of the
optimal savings rate. (Hint: See Figure 5.3 in Jones.)

(c) Describe what happens if we save more than the optimal savings rate. (Hint:
think about the marginal production of capital in the steady state and what becomes
inefficient if we save more.)

3. In this problem, you will work with the Constant Elasticity of Substitution (CES)
production function. The CES production function with inputs capital K and labor L
is given by
[ 1
]
1 1
Y = F (K, L) = K + (1 )L , (1)

where the parameter represents the different weights placed on K and L. Regarding
, assume 0 < . We will see in part (b) whats the economic interpretation of the pa-
rameter .

(a) Prove that (1) has the Constant Returns to Scale (CRS) property.

(b) Write the definition of the elasticity of substitution. Explain the economic mean-
ing of it with the capital/labor ratio and the price ratio (r/w), where the capital rental
rate is r and the wage rate is w. Prove that is the Elasticity of Substitution of (1).

(c) Prove that (1) has the following 3 special cases:

lim1 Y = K L1 (Cobb-Douglas) (Hint: take logs before taking the limit and
1
You dont need Jones and Vollarth textbook to work on this problem.
2

apply LHospitals rule.)

lim0 Y = min{K, L} (Walras-Leontief) (Hint: take the min{K, L} out of the

large bracket in (1).)

lim Y = K + (1 )L (Linear)

(d) Prove that the marginal productivity of labor (MPL) is given by y kf (k) and
the marginal productivity of capital (MPL) is given by f (k), where the lower case letters
F (K,L)
denote the per capita variables. That is, y YL , k K
L , f (k) L (but in terms of k.)

(e) The firm profit maximization implies (MPL)=w, (MPK)=r. Using these equations
prove that y = (1 ) w . What does this result imply on the relationship between
the wage rate and the output per capita?

(f) Calculate the labor share of income wL

Y . Does the share change with y? Is it con-
sistent with the Kaldors facts we discussed in class?

4. In the context of the Solow model with no technological progress, assume the CES
production function instead of Cobb-Douglas. Provide some parameter restriction(s)
with which you will always have sy > (n + )k, or equivalently, k > 0 and therefore
perpetual growth. (Hint: Draw a Solow diagram and think about the slope of sy and its
limit.)