Economic Growth ECON UH 3030
Problem Set 8
Fall 2024
Questions 1 and 2 are mandatory, question 3 is a bonus.
1 Output per capita vs consumption per capita
1
Take the basic Solow model, with steady state k ∗ = sA
.
1−α
δ
1. Solve for steady state income per capita and consumption per capita.
2. What is the savings rate that maximizes steady state consumption per
capita?
3. What is the marginal product of capital in steady state?
4. Is the value of s you found above consistent with the golden rule ( ∂K
∂Y
−δ =
g)? (in the basic case, g = 0).
5. Suppose the economy is not yet at the steady state and s > α. If s drops
to s = α, does any future generation get worse off?
6. Suppose the economy is not yet at the steady state and s < α. If s
increases to s = α, does any future generation get worse off?
2 Are we at the Golden Rule?
The World Bank provides data on real GDP growth and real interest rate for
many countries. You can download this data easily in excel on the follwing
webpages
• Real GDP: https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG
• Real interest rate: https://data.worldbank.org/indicator/FR.INR.RINR
1. Pick any country you are interested in and compute the average growth
rate and interest rate in the last 10 years.
2. Is the country at the Golden Rule?
1
3. Discuss some type of policy the government could implement if it wanted
to reach the golden rule. Would it benefit everyone in terms of consump-
tion, or would some people get hurt?
4. Suppose that capital was actually useful in generating new ideas to im-
prove technology. What would be the problem with using the golden rule
from the Solow model?
3 Endogenous savings rate in the Solow model
(bonus)
In the Solow model, the saving rate s is exogenous. We don’t allow people to
chose how much they save, so we might end up somewhere else than the golden
rule. What if we let them choose how much to save?
Suppose that we are in the basic Solow model without technological growth
or population growth. The only difference is that people live for two periods
(working age and retirement). In the working age, they work and choose how
much to save for retirement. In the retirement age, they don’t work and spend
their savings instead. Whenever a generation dies, a new is born so total pop-
ulation is constant and total working population is constant.
The utility of someone working in period t is given by:
U = (ct )β (ct+1 )1−β
1. Interpret β. Regardless of their income, what fraction of their income
will the agent save? (Hint: this is a Cobb-Douglas utility function. The
exponents are very much related to optimal the share of spending on the
different goods.)
2. Suppose the income of each agent is the wage wt . How much total savings
will there be at time t if the total working-age population is Lt , as a
function of wt , β and Lt ?
3. Suppose that the production function is the usual one (Yt = A(Kt )α (Lt )1−α )
and that the wage is equal to the marginal product of labor (why should
it?). What are the total savings in the economy as a function of β, α and
Yt ?
4. Write down the 4 key ingredients of this particular growth model in the
aggregate (production function, aggregate ressource constraints, aggregate
behavioral equation, law of motion). This economy is equivalent to the
Solow model, with a specific value of the savings rate. What is this savings
rate?
5. Under what condition is the (endogenously chosen) saving rate equal to
the golden rule rate (you solved for it in question 1)? What happens if β
is too high or too low?
