Econ 314 Prelim 2 (Fall 2008) 1. (10 points) Explain why it is impossible to have the net return for renting capital equal to 4% and the return for lending equal to 4% (that is, r t − 4% and i t − 1 5%). 2. (10 points) The individual maximizes U c0 , c 1 c0 c 1 subject to 2 c0 c 1 1. What is the optimal c0 , c 1 ? 3. (50 points) Consider the version of life-cycle model with u c yt , c ot 1 ln c ot 1 and F A t , K t , L t A t K t L t 1 − and with constant population. Let N 10, 0.5, A t 4all t ,and K0 90. The government provides public services in the amount of G 10, all t .Let g G / N .Let k t denote the capital holding per old person at the start of t . (1) Suppose that the government balances the budegt each t (sonodeficit)andthat G is financed by taxing old people. Explain why the transitional equation is k t 1 1 − A t k t . Then compute the steady state values of each old person’s consumption, and each person’s
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