Practice-Test

ADVANCED MACROECONOMIC THEORY: ECON 6201
PRACTICE TEST
Directions: The exam has three parts:
Part I – answer all questions.

Part II – answer one question (if more than one question is answered, only the first will be graded).
**Important: In derivations, show all steps. Be neat: sloppy answers will not be graded.
Part I – answer all questions
1) The Solow Growth Model (30 points) Let a be capital per unit of effective labor. In this case, the Cobb-
Douglas production function becomes y = a α , and the fundamental equation for the tax-augmented Solow
economy becomes a& = s a α (1 − τ ) − (n + g + δ )a , where all symbols other than a are defined as in class (recall τ is
the tax rate on income).
A) Derive the BGP solutions for capital and output.
a) Suppose the rate of economic depreciation increases, ceteris paribus. State how this change would affect
the Balanced Growth Path (BGP) values of a and y:
The BGP value of a will _________________. The BGP value of y will __________________.
b) Now support your answers in words, by explaining, in economic terms, why the increase in
depreciation causes the BGP values of capital and output to change. Use words not symbols.
c) Now support your answers by drawing a carefully and completely labeled graph showing how the BGP
value of capital and output are affected by the increase in depreciation (written explanation is not necessary).
B) Before period t0 the economy is on a BGP and the depreciation rate is low: At t0 the depreciation rate increases,
and the economy regains BGP at t1. Draw time paths for the following (written explanation is not necessary):
a) capital stock, per unit of effective labor

b) required saving, per unit of effective labor (that is, “breakeven” investment)
c) net saving, per unit of effective labor
d) the natural log of the standard of living
e) the growth rate of the standard of living
2) Convergence (25 points)
A) The two most fundamental questions in growth theory are questions about “convergence.” State the two
fundamental questions of growth theory.
B) Carefully describe Baumol’s empirical tests of the Solow model (restrict your discussion to Baumol). Do
Baumol’s empirical results support convergence? Explain your answer.
C) Carefully describe DeLong’s criticism of Baumol. Do DeLong’s empirical results support convergence?
2
Explain your answer. Restrict your discussion to Baumol and DeLong.
Part I, continued
3) Dynamic Inefficiency (20 points)
A) Explain (in words: no graph necessary) what is meant by “dynamic inefficiency.”
B) Draw a carefully and completely labeled graph illustrating an economy whose BGP is dynamically
inefficient.
C) briefly describe empirical evidence for or against dynamic inefficiency.
Part II – answer one question (25 points)
4) The Consumption Function: The Diamond Model consumption function is
1
C1,t = 1
At ⋅ wt .
1 ⎡1 + rt +1 ⎤ θ
1+
1 + rt +1 ⎢⎣ 1 + ρ ⎥⎦
⎛1 ⎞
Assume the intertemporal elasticity of substitution is less than one: that is, ⎜ < 1⎟ . Now suppose rt+1
⎝θ ⎠
increases, ceteris paribus.
A) State how the increase in rt+1 would affect C1,t, S1,t, and C2,t+1 [S1,t is saving by the young in period t].
C1,t would __________________, S1,t would __________________, C2,t+1 would _________________.
B) Support your answer algebraically, by using the consumption function to indicate why C1,t must change.
C) Now support your answers on C1,t, S1,t, C2,t+1 , in words, by explaining in economic terms, why the
changes occur.
D) Suppose ρ increases: how would this affect C1,t? (written explanation is not necessary). Does the
1
direction of change in C1,t depend on ? Why or why not?
θ
5) Growth:
A) Define absolute convergence and conditional convergence. Can these concepts be used to reconcile Baumol’s
and DeLong’s empirical evidence? Explain your answer.
B) Describe Feldstein and Horioka’s empirical results. Why are they important?
C) Assume free international trade and perfect capital mobility. Suppose, initially, that A and B are exactly
alike in every way, including identical saving rates. Now suppose Country A’s saving rate declines. How
will the marginal products of capital in A and B be affected, both initially and in the long run.
3
6) Dynamic Efficiency
1
A) Is dynamic efficiency most likely to occur when the intertemporal elasticity of substitution, is very small
θ
or when it is very large? Explain your answer.
B) Is dynamic efficiency most likely to occur when (n+g+δ) is very small or when it is very large? Explain
your answer.
C) Is dynamic efficiency most likely to occur when the exponent on capital in the Cobb-Douglas production
function is very small or when it is very large? [Recall y=kα] Explain your answer.
7) The Consumption Function (again): Assume logarithmic utility. Then utility in the Diamond model is
ln(C 2, t +1 )
U = ln(C1,t ) + .
1+ ρ
The lifetime budget constraint remains as in class notes.
A) Derive the Euler equation for this model.
B) Use the Euler equation and the lifetime budget constraint to derive a solution for C1,t (that is, derive the
consumption function).
C) Suppose time preference increases. How will this affect C1,t, S1,t , C2,t+1. Explain your answers.
8) Miscellaneous:
1
A) Will the economy be stable or unstable if < 1 ? Explain your answer.
θ
B) Recall question 1) in Part I. How would an increase in the depreciation rate affect BGP consumption in
effective labor units? Support your answer mathematically. Then explain in economic terms why
consumption changes as it does.

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ADVANCED MACROECONOMIC THEORY: ECON 6201

Directions: The exam has three parts:

Part I – answer all questions.

Part I – answer all questions

A) Derive the BGP solutions for capital and output.

a) capital stock, per unit of effective labor

2) Convergence (25 points)

A) Explain (in words: no graph necessary) what is meant by “dynamic inefficiency.”

C) briefly describe empirical evidence for or against dynamic inefficiency.

Part II – answer one question (25 points)

4) The Consumption Function: The Diamond Model consumption function is

The lifetime budget constraint remains as in class notes.

A) Derive the Euler equation for this model.

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