GROWTH THEORY: FIRST ASSIGNEMENT

CHIARA FARRONATO AND PAOLO PIACQUADIO

Solutions

Exercise 1
1a)
The Cobb-Douglas technology is described by the following:
f (kt ) = ktα = yt
with 0 < α < 1. 1 α
Assuming the following change of variable zt = kt1−α , we obtain kt = zt1−α and, deriving with respect to time, k̇t = 1
1−α zt
1−α
z˙t
. Substituting in the dynamic of capital k̇ = sf (kt ) − (δ + γ + n) kt will give:
1 α α 1
zt1−α z˙t = szt1−α − (δ + γ + n) zt1−α
1−α
żt = (1 − α) s − (1 − α) (δ + γ + n) zt

[żt + (1 − α) (δ + γ + n) zt ] e(1−α)(δ+γ+n)t = s (1 − α) e(1−α)(δ+γ+n)t

s
zw e(1−α)(δ+γ+n)w t0 =

e(1−α)(δ+γ+n)w t0

δ+γ+n
(1−α)(δ+γ+n)t s s
zt e − z0 = e(1−α)(δ+γ+n)t −
δ+γ+n δ+γ+n
 
s s
zt = + z0 − e−(1−α)(δ+γ+n)t
δ+γ+n δ+γ+n
substituting back to have the equation in kt :
   1
 1−α
s s
kt = + k01−α − e−(1−α)(δ+γ+n)t
δ+γ+n δ+γ+n
1b)
dlog(y)
gy =
dt
   α
 1−α
s 1−α s −(1−α)(δ+γ+n)t
yt = + k0 − e
δ+γ+n δ+γ+n
The steady state level of production is found as the limit for t → ∞:
 α
 1−α
s
yss =
δ+γ+n
The logarithm will be:
   
α s s
log(y) = log + k01−α − e−(1−α)(δ+γ+n)t
1−α δ+γ+n δ+γ+n
The time derivative:
 
1−α s −(1−α)(δ+γ+n)t
dlog (y) α − (1 − α) (δ + γ + n) k0 − δ+γ+n e
= h   i
dt 1−α s
+ k 1−α
− s
e −(1−α)(δ+γ+n)t
δ+γ+n 0 δ+γ+n
1
 GROWTH THEORY: FIRST ASSIGNEMENT 2

h   i
− k01−α − s
δ+γ+n e−(1−α)(δ+γ+n)t − δ+γ+n
s s
+ δ+γ+n
= α (δ + γ + n) h   i
s
δ+γ+n + k01−α − δ+γ+n
s
e−(1−α)(δ+γ+n)t
That rearranged and substituting for the steady state level of production gives:
" − 1−α #
yt α
gy = α (δ + γ + n) −1
yss
1c)
The convergence coefficient is given by:

dgy
β=−
dlog (y)
we put zt = log (yt ) , which implies yt = ezt :
" − 1−α #
ezt α
gy = α (δ + γ + n) −1
yss
In the derivation dlog (yt ) = dzt , so:
   zt − 1−α
dgy 1−α e α
β=− = −α (δ + γ + n) −
dzt α yss
 − 1−α
yt α
β = (1 − α) (δ + γ + n)
yss
so, the convergence speed around the steady state, where yt ∼
= yss , is:

β∼ = (1 − α) (δ + γ + n)
The convergence speed around
 the steady state will not depend on the distance from the steady state (arbitrarily close to
zero), expressed by the ratio yysst → 1, but only on the parameters of the model.
The saving rate s doesn’t affect the convergence speed β because there are 2 forces that around the steady state perfectly
offset each other: on one hand a higher saving rate leads to greater investment (positive effect on β); on the other hand it raises
the capital intensity and lowers the average product of capital (negative effect).
In the same way also the state of technology A (the level and not the growth rate) doesn’t play any role in the convergence
speed around the steady state since it affects the saving rate.

2)
1
F (K, L) = A (αK ρ + (1 − α) Lρ ) ρ
2a).
    ρ  ρ1
F (Kt , Lt ) Kt Kt 1
=F , 1 = At α + (1 − α) = At (αktρ + (1 − α)) ρ = f (kt )
Lt Lt Lt
Checking for assumptions A1: ∀k > 0, f (k) > 0, f (k) > 0, f 00 (k) < 0
0

1 ?
f (k) = A (αk ρ + (1 − α)) ρ > 0
this condition is verified ∀k > 0 if we assume A>0 and 0 ≤ α ≤ 1.
1
−1 ?
f 0 (k) = αAk ρ−1 (αk ρ + (1 − α)) ρ >0
this is verified ∀k > 0 if we assume A>0 and 0 < α ≤ 1.
1 1
−1 −2
f 00 (k) = (ρ − 1) αAk ρ−2 (αk ρ + (1 − α)) ρ + α2 A (1 − ρ) k 2(ρ−1) (αk ρ + (1 − α)) ρ
 GROWTH THEORY: FIRST ASSIGNEMENT 3

1
h i ?
−1 −1
= αA (1 − ρ) k ρ−2 (αk ρ + (1 − α)) ρ αk ρ (αk ρ + (1 − α)) − 1 < 0
h i
−1
We assume A > 0 and 0 < α ≤ 1. If ρ > 1, we need αk ρ (αk ρ + (1 − α)) − 1 to be positive, but this will never be the
ρ
αk
case since αkρ +(1−α) < 1. If ρ = 1, f”(k) will be equal to zero so the only case that verifies this assumption is when ρ < 1.
Checking for assumptions A2: lim+ f 0 (k) = +∞ and lim f 0 (k) = 0 (the Inada conditions).
k→0 k→∞
1
−1
lim f 0 (k) = lim αAk ρ−1 (αk ρ + (1 − α)) ρ
k→0+ k→0+

= lim αAk −ρ(

1−ρ
ρ ) (αk ρ + (1 − α)) 1−ρ
ρ
k→0+

1−ρ
= lim+ αA α + (1 − α) k −ρ ρ

k→0
the limit will depend on the value of the ρ parameter:

 lim f 0 (k) = ∞ if 0 ≤ ρ < 1
+
k→0
1
0
 lim f (k) = Aα
+
ρ if ρ < 0
k→0
for the other limit:

1−ρ
lim f 0 (k) = lim αA α + (1 − α) k −ρ ρ

k→∞ k→∞
again it will depend on the value of the ρ parameter:
 1
 lim f 0 (k) = Aα ρ if 0 < ρ < 1
k→∞
 lim f 0 (k) = 0 if ρ ≤ 0
k→∞
Checking for assumption A3: lim+ f (k) = 0.
k→0
1 ?
lim A (αk ρ + (1 − α)) ρ = 0
k→0+
this is the case if ρ ≤ 0 (since the CES will become a Cobb-Douglas production function) or if α = 1 . In the first case:

lim f (k) = 0
k→0+
In the second case:
1
lim A (1k ρ + (1 − 1)) ρ = 0
k→0+
At the end; given that A > 0 and 0 ≤ α ≤ 1 we have:
• A1 is satisfied if α 6= 0 and ρ < 1
• A2 is satisfied if α 6= 0 and ρ = 0
• A3 is satisfied if α 6= 0 and ρ ≤ 0 or if α = 1.
2b). Let’s write the dynamic of per-capita capital k:

k̇ = sf (k) − (δ + γ + n) k
to have the steady state of k we just impose k̇ = 0:
1
sA (αk ρ + (1 − α)) ρ = (δ + γ + n) k
assuming k 6= 0:

ρ1
sA α + (1 − α) k −ρ = (δ + γ + n)

f (k)
s = (δ + γ + n)
k
Let’s write it as a system of 3 equations:
 GROWTH THEORY: FIRST ASSIGNEMENT 4


 h = (δ + γ + n)
H = s f (k)
k
h=H


Since we demonstrated that for ρ < 1 the first order derivative is decreasing and convex the H function should be greater
than the h function for the limit of k going to 0 and less for the limit of k going to infinite. In the following graph the conditions
become clear:

By the previous conditions we will have existence and uniqueness when:

 1
 sAα ρ < δ + γ + n if 0<ρ<1
1

 sAα > δ + γ + n if ρ<0

ρ

always if ρ=0

1
2c). Assuming γ = 0 , ρ < 0 , sAα ρ < δ + n.
1
The condition required for the existence of an interior steady state is not satisfied since lim+ sfk(k) = sAα ρ < δ + n: the
k→0
per-capita capital will decrease whatever the initial level k0 .
In fact kk̇ = s f (k)
k − (δ + γ + n) < 0. From the graph:
 GROWTH THEORY: FIRST ASSIGNEMENT 5

1
2d). Assuming γ = 0 , 0 < ρ < 1 , sAα ρ > δ + n.
sf (k) 1
Also in this case the conditions required for the existence of an interior steady state are not satisfied since lim k = sAα ρ >
k→∞
δ + n : this implies that there will not exist a steady state per-capita capital, but capital will always growth whatever the initial
level k0 and will never converge. From the graph:

The stationary growth rate of per-capita capital will be found by making the capital tend to infinity:
 GROWTH THEORY: FIRST ASSIGNEMENT 6

k̇ 1
gk = lim = sAα ρ − (δ + n)
k→+∞ k
The growth rate of output can be found in the following way:

ẏ f 0 (k) k̇ f 0 (k) k
gy = lim = lim = gk lim
k→+∞ y k→+∞ f (k) k→+∞ f (k)
but since:
1
−1
f 0 (k) k αAk ρ−1 (αk ρ + (1 − α)) ρ k αk ρ
lim = lim 1 = lim =1
k→+∞ f (k) k→+∞ A (αk ρ + (1 − α)) ρ k→+∞ αk ρ + (1 − α)
1
the long run growth rate of per capita capital and per capita output are the same: gk = gy = sAα ρ − (δ + n)

Exercise 2
Specifications of the model

α 1−α
Y = AK L

K̇ = I − δK = sY − δK

 L̇ −β
L = n + ay with a > 0, β > 1/α > 0
2a). The specification of the demographic of the model tells that the growth rate of the population is given by a constant trend
n added to a term which depends negatively on per-capita production: this is a specification that allows to model the empirical
fact that richer people have statistically less children.
2b).
y = Ak α
 ˙ 
K K̇L − K L̇ K̇ L̇
k̇ = = = − k
L L2 L L

k̇ = sy − δk − n + ay −β k

k̇ = sAk α − aA−β k 1−αβ − (δ + n) k

In order to compute steady states of the model we take k̇ = 0:

sAk α − aA−β k 1−αβ − (δ + n) k = 0

Searching for a steady state for a positive per-capita capital level, we can divide by k:

sAk α−1 − (δ + n) = aA−β k −αβ

Since it is not possible to solve this equation analytically, we derive separately the behavior of each part of the equality and
look for the steady state characterization by comparing the results.
We call g(k) = sAk α−1 − (δ + n) and l(k) = aA−β k −αβ .

g 0 (k) = (α − 1) sAk α−2 < 0

g 00 (k) = (α − 1) (α − 2) sAk α−3 > 0

lim g(k) = ∞
k→0+

lim g(k) = − (δ + n)
k→∞
 GROWTH THEORY: FIRST ASSIGNEMENT 7

l0 (k) = −αβaA−β k −αβ−1 < 0

l00 (k) = αβ (αβ + 1) aA−β k −αβ−2 > 0

lim l(k) = ∞
k→0+

lim l(k) = 0
k→∞

For lim we know that l(k) is greater then g(k). For lim+ we have to verify which function tends to infinity faster: which is
k→∞ k→0
g(k)
equivalent to check whether the ratio l(k) tends to infinity or to zero.

g(k) sAk α−1 − (δ + n) s − (δ + n) αβ

lim+ = lim+ = lim+ A1−β k α−1+αβ + lim+ k =0
k→0 l(k) k→0 aA−β k −αβ k→0 a k→0 aA−β

since for hypotesis α − 1 + αβ > 0.

This implies that both for k going to infinity and for k going to 0, the l(k) function is greater then the g(k) function: a first
graph representing this is given by the following:

Notice that until now it’s not possible to say anything about the number of steady-states.
The first step is to check all the k such that g 0 (k) = l0 (k): the number of possible steady-states is limited by the number of
k solving the equality of the first order derivatives plus one. There is only one k for which g 0 (k) = l0 (k):

(α − 1) sAk α−2 = −αβaA−β k −αβ−1

 1
 α+αβ−1
αβ a
k̄ =
1 − α sA1−β



Three cases can therefore


the g
(k) and the l (k) curve (in this case l k̄ > g k̄ ), one intersection

arise: no intersection between
with tangency (l k̄ = g k̄ ) or two intersections l k̄ < g k̄ .
Let’s start with the tangency case:
 GROWTH THEORY: FIRST ASSIGNEMENT 8

In this case g k̄ = l k̄ , or:

sAk̄ α−1 − (δ + n) = aA−β k̄ −αβ

substituting for the value of k̄, gives the conditions for the unique steady-state case to arise:
 α−1
 α+αβ−1  −αβ
 α+αβ−1
αβ a −β αβ a
sA − (δ + n) = aA
1 − α sA1−β 1 − α sA1−β
In this case there is a unique value of per capita capital that is able to produce a sufficient output that will keep the per capita
capital level constant: for higher capital levels the decreasing marginal rates of production in per capita capital is stronger then
the negative effect of a higher capital on the population dynamics implying a decrease of per capita capital level. For lower per
capita capital levels, the marginal increase of productivity of capital is lower then the effect of a lower per capita output on the
demographic, making the per capita capital level decrease. This equilibrium is therefore not stable.
h α−1
i α+αβ−1 h −αβ
i α+αβ−1
αβ a −β αβ a



If g k̄ < l k̄ , that is if sA 1−α sA 1−β − (δ + n) < aA 1−α sA 1−β , the case of no steady states will arise:

In this case the negative effect of the output on the demographic is never sufficient to allow some accumulation process to take
place: the demographic trend is so strong compared to the productivity of capital that there is no value of per capita capital
that is able to produce a sufficient quantity of goods that makes the per capita capital constant. In fact, the growth rate of the
population is so high that, whatever the initial level k0 , the per-capita capital will fall to zero.
h α−1
i α+αβ−1 h −αβ
i α+αβ−1
αβ a −β αβ a



The last case arises if g k̄ > l k̄ , that is if sA 1−α sA1−β − (δ + n) > aA 1−α sA 1−β ; the case of two
different steady states:
 GROWTH THEORY: FIRST ASSIGNEMENT 9

In this case there will be two steady states, k and k ∗ . The first one will be unstable, while the second one is stable. So if the
initial per capita capital level is below k it’s not possible to accumulate per capita capital since the extrimely strong demographic
trend makes this impossible: if instead the initial per capita capital level is above this threshold, the economy will smoothly
converge to the interior stable steady state k ∗ .
Technically there is no poverty trap, if interpreted as a stable low (but positive) stable per capita capital level; but in all these
models zero per capita capital level is an attractor, so for low initial levels of capital this will be the long run equilibrium.

Exercise 3. Standard Ramsey model except for the following utility function:

1
u(c) = − e−θc
θ
3a). The intertemporal elasticity of substitution is given by the formula:

u0 (ct )
σt = −
u00 (ct ) ct
the inverse of the negative of the elasticity of marginal utility. Since it represents the cost of transferring consumption from
one period to the next, a large value of σ indicates a low saving rate, so that the saddle path that converges towards the stable
steady state will be concave because the consumption will be very close to the production function. On the other hand, if σ is
small, consumption will depart greatly from the production function because of the high saving rate so that the saddle path is
convex.
For this utility function, we have:

u0 (c) = e−θc

u00 (c) = −θe−θc

so the intertemporaly elasticity of substitution is:

u0 (c) 1
η=− =
u00 (c)c cθ
The IES gets smaller as the level of consumption per capital increases: this means that the saddle path gets more concave
as consumption rises towards the steady state and households care relatively more about consumption smoothing (notice that if
capital and consumption approach the steady state from the right the saddle path will be convex).
 GROWTH THEORY: FIRST ASSIGNEMENT 10

3b). The problem is the following:

´∞
M ax − θ1 e−θc e(n−ρ)t dt
0
s.t. k̇ = f (k) − c − (δ + n) k
k (0) given
Let’s write the Hamiltonian:

1
H = − e−θc e(n−ρ)t + v [f (k) − (δ + n) k − c]
θ
The first order condition for the maximization problem are:

∂H −θc (n−ρ)t
∂c = 0 ⇒ e e =λ



− ∂H 0
= λ̇ ⇒ (n + δ − f (k)) λ = λ̇

∂k
∂H


 ∂v = k̇ ⇒ k̇ = f (k) − (δ + n)k − c
 lim λt kt = 0

t→∞
Deriving the first equation with respect to time and substituting in the second:

∂ −θc (n−ρ)t
λ̇ = e e = −θe−θc ċe(n−ρ)t + (n − ρ) e−θc e(n−ρ)t
∂t
will give the system of dynamics of capital and consumption:
(
ċ = θ1 [f 0 (k) − (δ + ρ)]
k̇ = f (k) − (δ + n)k − c
The phase diagram of this system is the following:

To compute the steady states, we just equalize to zero:

(
0 = θ1 (f 0 (k ∗ ) − (δ + ρ))
0 = f (k ∗ ) − (δ + n) k ∗ − c∗
Let’s for example assume a Cobb-Douglas production function: we find k ∗ from the first equation since f 0 (k) = αk α−1 ;
substituting in the dynamics of capital we find the corresponding consumption level:
  1
∗ δ + ρ α−1
k =
α
 α
 α−1  
δ+ρ α
c∗ = 1 − (δ + n)
α δ+ρ
In order to study the local stability we linearize around the steady-state by first order Taylor approximation:
 GROWTH THEORY: FIRST ASSIGNEMENT 11

∂ ċ ∂ ċ
c − c∗
     
ċ ∼ ∂c ∂k
=
k̇ c = c∗ ∂ k̇
∂c
∂ k̇
∂k
k − k∗
k = k∗
The matrix of the coefficients of this linear system of two equations is the following:
 h i α−2 
1 00 ∗
  α−1
0 δ+ρ
θ f (k )
1
= 0 θ α (α − 1) α
−1 f 0 (k ∗ ) − (δ + n)

−1 ρ−n
The characteristic equation of the system is:

1
λ2 − λ [f 0 (k ∗ ) − (δ + n)] + f 00 (k ∗ ) = 0
θ
  α−2
1 δ + ρ α−1
λ2 − λ [ρ − n] − α (1 − α) =0
θ α
So the eigenvalues are:
r
h i α−2
α−1
2 δ+ρ
ρ−n± (ρ − n) + 4 θ1 α (1 − α) α
λ1,2 =
r 2
h α−2
i α−1
2
Since (ρ − n) < (ρ − n) + 4 θ1 α (1 − α) δ+ρα , there will be a positive and a negative eigenvalue. So the steady state
found is a saddle point and is economically stable.
3c). The convergence speed (around the steady state) of the model is given by the absolute value of the negative eigenvalue of
the linearized system:
 r
h i α−2 
 ρ − n − (ρ − n)2 + 4 1 α (1 − α) δ+ρ α−1 

 θ α 
β = |λ| =  
 2 

 
c1−θ −1
In the case of an isoelastic utility function U (ct ) = t1−θ , the dynamics of the system will be:
(
ċ = θc [f 0 (k) − (δ + ρ)]
k̇ = f (k) − (δ + n)k − c
The linearized system around the steady state (notice that the steady state does not change):
 h i α−2
α−1
h α
i α−1 
2 δ+ρ δ+ρ
1 00
(k ∗ ) c∗  0 − θ1 α (α − 1)
 
0 θf α α
=

0 ∗ i α−1
−1 f (k ) − (δ + n) h 
δ+ρ α−1
−1 α α − (δ + n)
And the convergence speed will be:
 r h ih i
 ρ − n − (ρ − n)2 + 4 θ1 α (1 − α) δ+ρ δ(1−α)+ρ−αn 

α α
β 0 = |λ0 | = 
 

 2 

 
In order to compare the convergence speeds we rewrite them in the following way:
  q 
00 ∗ ) 
 ρ−n− (ρ−n)2 −4 f (k

q   θ
  β=
  
2

 ρ − n − (ρ − n) − 4 · IES · c∗ f 00 (k ∗ )   2
 
 
convergence speed = 

=
  q 
2 
ρ−n− (ρ−n) 2
−4c∗ f 00 (k∗ ) 

 β0 =  θ
  
  
  2 

The only difference in the convergence speed is given by the presence of the steady state level for consumption c∗ .
 GROWTH THEORY: FIRST ASSIGNEMENT 12

So if c∗ > 1 the converence speed (around the steady state) of the isoelastic utility function β 0 is higher then β. The reverse
result holds if c∗ < 1. While the convergence speeds are the same if c∗ = 1. Notice that with the first utility function the
convexity of the saddle path changes as c increases, while it is independent on consumption when we assume the second utility
function.

In general, the convergence speed is higher for a higher steady state of consumption (see the general formula for the convergence
1
speed), but in the first case, where IES = θc , the change of intertemporal elasticity of substitution (that decreases as consumption
increases) will perfectly offset the consumption effect.