Economics of Growth (HS 30087)

Department of Humanities and Social Sciences

Midterm Examination (Autumn 2015)
Answer all questions
1. Consider a Solow growth model where, production function is, () = () () ,

where, < < 1 and there is no depreciation of capital stock. Suppose, individual saves
< < 1 proportion of their wage income and < < 1 proportion of their rental

income and < . (10)

(a) Suppose,

= , 0 < < 1. Write down the fundamental equation of the Solow model in

continuous time per capita form. (1)

(b) What is per capita capital stock at the steady state? What is growth rate of per capita output at
the steady state? Give a graphical representation of your analysis. (4)

(c) Now assume, = () < when () <

= , 0 < < 1 otherwise

What is per capita capital stock at steady state? Give a graphical representation of your analysis.
What is steady state growth rate? (5)
2. Consider a Solow model with per capita production function, () = (). The

and
production function is standard. Assume that savings rate is, when ()

with > . Population is growing at the rate , < < 1 and there is
when, () >

no depreciation of capital. (5)

(a) Write down the fundamental equation of Solow model in continuous time in per capita form.
How many steady states are there? (2)
(b) Graphically analyze the stability of each steady state. (2)
(c) How your analysis addresses the issue of poverty trap? (1)
3. Consider a R-C-K model with instantaneous utility function () = () and

production function, () = (). There is no population growth, no technology growth

and no depreciation of capital. Subjective discount rate is, . (15)

(a) Write down resource constraint and social welfare function of the social planner. (1)

(b) Set up the dynamic optimization problem of social planner. (1)

1

(c) Derive the first order condition of the problem you set up. Write down the time path of capital, output,
marginal utility of consumption and consumption along the Balanced Growth Path. Check if
Transversality Condition is satisfied along Balanced Growth Path. (3)
(d) Intuitively explain the dynamics of marginal utility of consumption. (1)
(e) Suppose, initial capital stock is (0), technology level . Determine initial consumption, (0), initial

output, (0) and initial marginal utility of consumption, (0). Determine growth rate of consumption,

marginal utility of consumption, capital and output along the Balanced Growth Path. (3)

(f) Suppose, only rises from to at = 1 where > . Write down the time path of capital,
consumption and output separately for = 0, 1, 2, , 1 and = 1 + 1 onwards. Plot the time path of
capital, consumption and output separately, when time is measured along the horizontal axis

corresponding variable is measured along the vertical axis. Analyze the impact of change in on time
path of consumption, capital and output. (5)

(g) Compare savings rate and its growth rate under both lower and higher technology level. Explain your
result intuitively. (1)