UNIVERSITY OF OSLO
DEPARTMENT OF ECONOMICS
Term paper in: ECON4350 – Growth and investment
Handed out: Thursday, March 22, 2007
To be delivered by: Thursday, April 12, 2007 at 01:00 – 03:00 p.m.
Place of delivery: Next to SV-info-center, ground floor
Further instructions:
• This term paper is compulsory. Candidates who have passed the compulsory term paper
in a previous semester, does not have the right to hand in the term paper again. This is so,
even if the candidate did not pass the exam.
• You must use a printed front page, which will be found at
http://www.oekonomi.uio.no/info/EMNER/Forside_obl_eng.doc
• Note: You can write an individual paper, or hand in joint work (gruppebesvarelse).
However, we do not allow more than 3 students in each group! Please use only one front
page!
• It is of importance that the term paper is delivered by the deadline (see above). Term
papers delivered after the deadline, will not be corrected.*)
• All term papers must be delivered to the place given above. You must not deliver your
term paper to the course teacher or send it by e-mail.
• If the term paper is not accepted, you will be given a new attempt. If you still not
succeed, you will not be permitted to take the exam in this course. You will then be
withdrawn from the exam, so that this will not be an attempt.
*) If a student believes that she or he has a good cause not to meet the deadline (e.g. illness) she or he should
discuss the matter with the course teacher and seek a formal extension. Normally extension will only be granted
when there is a good reason backed by supporting evidence (e.g. medical certificate).
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ECON 4350: Growth and Investment
Assignment for term paper
Department of Economics, University of Oslo
Spring 2007
Groups of one two or three students can submit a joint paper (only hand
in one copy). Remember to provide the relevant data for all participating
students on the front page. You can write your paper in either English or
Norwegian. Strive to make your answers to the questions short and to the
point.
Problem 1
In this exercise you are asked to consider a competitive equilibrium in an
economy with utility-maximizing households, profit-maximizing firms, and a
government that runs balanced budgets at all points in time:
G + V = τwwL + τar · (assets) + τcC + +τf · (firm’s earnings)
You should take as your starting point the model presented in lecture note
4 (Section 8.3). The notation used in this exercise adheres to the notation
introduced there.
(a)
Households maximize the utility function
U =
∞
t=0
u(c(t))Lh(t)e−ρt
dt (1)
Where c(t) equals the consumption level of each household member and Lh(t)
is the size of the household (below Lh(t) ≡ ent
). Discuss the interpretation
of this formulation of preferences.
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(b)
Assume that the utility function is of the CRRA-type, with the constant
relative risk aversion denoted by θ. The per capita budget of the household
is
˙a = (1 − τw) · w + (1 − τa) · ra − (1 + τc) · c − na + v (2)
Formulate the optimization problem facing the household. Show that the
solution satisfies the Euler-equation
˙c(t)
c(t)
=
(1 − τa)r − ρ
θ
(3)
Discuss the interpretation of this condition.
(c)
Show that in equilibrium
˙ˆk = f(ˆk) − ˆc − (x + n + δ)ˆk − ˆg (4)
(d)
Characterize graphically the equilibrium of the economy, i.e. the paths {ˆk(t), ˆc(t)}.
(e)
Discuss reasons why we might want to model public spending differently.
(But stick to the original formulation in the analysis below.)
(f)
Outline how you could incorporate human capital into the model as an additional
accumulated input to production. Would this change your analysis
in important ways?
(g)
Explain the effects of an unanticipated and permanent increase in the tax on
consumption, i.e. τc.
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(h)
Explain the effects of an unanticipated and permanent increase in the tax on
asset income, i.e. τa.
(i)
Explain the effects of an unanticipated and permanent increase in public
spending, i.e. g.
(j)
What if the increase in public spending was anticipated?
(k)
What if the increase in public spending was unanticipated, but temporary?
(l)
Over the period 1740–1918 the UK real interest rate tends to be high during
war years. Can you explain this based on the analysis above?
Problem 2
You are an advisor to the Minister of Finance in Bugrica. She is concerned
about improving economic growth in her country. She has come across the
paper by Easterly and Levine (2001) [On the reading list] and wants you to
give her a briefing on the paper. You are expected to produce a report of a
maximum of 3 pages. The Minister is familiar with basic general economics,
but knows very little about theories of growth and does not like maths.
However, she is quite smart and understands a clear argument quickly. You
should focus on the following:
1. Provide the background for the paper, i.e. why are the questions raised
important for her concern for economic growth in her country.
2. Summarize the arguments (theoretical/empirical) in the paper.
3. Evaluate these arguments in light of your knowledge of growth theory
and empirics.
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4. Discuss possible implications for policy. Keep in mind that your summary
might have a direct impact on her decisions on economic policy.
N.B.: You can ignore Section V of the paper. But you are encouraged
to skim through it for a quite interesting read.
References
Easterly, William and Ross Levine, “It’s Not Factor Accumulation: Stylized
Facts and Growth Models,” World Bank Economic Review, 2001,
15 (2), 177–219.
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