Suggested Solutions for Midterm
Econ 702, Spring 2004
Omer Kagan Parmaksiz and Ahu Gemici
April 1, 2004
1
Problem 1: Growth Model
To answer this question properly, you need to realize that no trade occurs
if output cannot be transferred. Therefore, for the first five questions, the
economy is equivalent to a pair of autarchic economies. On the other hand,
for the last three questions, trade does occur.
1.1
Question 1
Since the values of shocks are set at their unconditional means, the economy
is equivalent to an economy without shock. So the allocation doesn’t depend
on the history of shocks. Since we know that the equilibrium is PO, we just
need to solve the social planner’s problem, and impose steady state condition,
in order to derive steady state equilibrium conditions.
The social planner’s problem in region M is:
max
{
c
M
t
,k
M
t
+1
,n
M
t
}
∞
t
=0
∞
t
=0
β
t
u
M
(
c
M
t
,
1

n
M
t
)
(1)
subject to
c
M
t
+
k
M
t
+1
=
f
M
(
z
M
, k
M
t
, n
M
t
) + (1

δ
)
k
M
t
Social planner’s problem in region B is (remember that the people in
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 Spring '08
 Staff
 Economics, Thermodynamics, Steady State, NM, M M M M

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