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EC 813A MACROECONOMICS PROBLEM SET 4. PLEASE HAND IN ON FRIDAY OCTOBER 24TH 1) Financial market imperfections. Consider a two period small open, production economy ( t =1 , 2 ). There are two goods: fruits and machines (denote K the stock of machines). Machines do not depreciate. Standard technological assumptions hold. There exists a 1:1 technology that allows to transform one fruit into one machine and a concave technology F ( K ) that produces fruits with machines. The representative agent has a standard concave utility function u ( c ) and discount factor β. The only initial endowment is a stock of machines K 1 while the initial f nancial wealth of the economy RB 1 =0 . There is only one f nancial activity (bonds) with gross interest rate R . The only "anomaly" of this economy is the existence of f nancial imperfec- tions. The economy cannot borrow from the rest of the world more than a fraction ϕ of the value of its machines. In other words the following constraint
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