Macroeconomics A, Final Exam

Duration: 2 hours

ECOM001, Academic year 2022/2023

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Examiners: Xavier Mateos-Planas and Tom Schmitz

© Queen Mary University of London, 2022

Question 1

(a) Explain the meaning of the term “non-rival” in economics.

(b) Explain how the non-rivalry of ideas generates increasing returns.

Question 2

Consider the neoclassical growth model without population growth and without technological progress.
The optimal consumption choice holds the Euler equation
ct+1 1
= (β (1 + rt+1 )) θ ,
ct
where ct ≡ Ct
L stands for consumption per person. As usual, the interest rate holds

1 + rt+1 = f ′ (kt+1 ) + 1 − δ,

where kt ≡ Kt
L is capital per person. Production is given by the Cobb-Douglas function

f (kt ) = ktα .

For simplicity, we will assume throughout this question that capital fully depreciates in production, i.e.,
δ = 1.

(a) Write down an equation for the law of motion for capital (i.e., express kt+1 as a function of kt and
ct ).

(b) Using your result from question (b), write down the two-equation system in consumption and
capital that characterises the dynamic behaviour of this economy.

(c) Represent the behaviour of this system graphically, using a phase diagram.

(d) Suppose the economy starts in period 0 from a very low level of capital per person k0 . How do
capital per person and consumption per person evolve over time?

(e) Suppose that the economy is initially in its steady state. Then, at some time T , there is an
(unanticipated) shock to the intertemporal elasticity of substitution, and θ increases to θnew > θ.
What will be the consequences of this shock for the economy?

[25 marks]

Question 3

Consider the following New Keynesian model involving output y, inflation π, and the nominal interest
rate i,
1
yt = Et yt+1 − (it − Et πt+1 ) + uIS
t
θ
n
πt = Et πt+1 + κ(yt − yt )
Page 3 ECOM001 (2022/2023)

where uIS
t and yt are stochastic. Suppose the policymaker’s loss function is given by
n

∞
X
E0 [(yt − ytn )2 + λπt2 ].
t=0

Briefly outline the meaning of these equations. Explain the optimal feasible policy and how it can be
implemented. What is the trade-off between stabilisation of inflation and stabilisation of output?
[25 marks]

Question 4

Consider a basic Real Business Cycle model equilibrium described by the following equations:
 
1 −ρ 1
= e Et (1 + rt+1 )
(1 − st )yt (1 − st+1 )yt+1
 
1 −ρ 1 wt
= e Et (1 + rt+1 )
1 − lt 1 − lt+1 wt+1
(1 − st )yt
b = wt
1 − lt
en kt+1 = st yt
yt = ktα (At lt )1−α
yt
rt = α − 1
kt
yt
wt = (1 − α)
lt
ln At = Ā + gt + Ãt
Ãt = ρA Ãt−1 + ϵA,t ,

where s represents the saving rate, y output, r the interest rate, l labour supply, w the wage rate, n
population growth, k capital, A productivity, and ϵA,t is an iid shock.

a) Explain the meaning of these conditions. What are the special assumptions that lend analytical
tractability to this version of the model?

b) Using log linearisation, characterise the behavior of labour supply and savings.

c) Derive an expression describing the behaviour of deviations of output from trend.

d) Discuss and assess the main implications of this simple model, including possible limitations.

[35 marks]

End of Paper