TERM 1: CA & production economy

Question 1

What do firms do in periods 1 and 2?

Answer 1

Period 1 = invest in physical capital

Period 2 = use capital to produce goods (Q2)

Question 2

Production function period 2

Answer 2

Q2 = A2 F(I1)

Question 3

Properties of production function (3)

Answer 3

1. F(0)=0
2. F’ > 0 - increasing
3. F’’ < 0 - concave = diminishing MPK

Question 4

MPK =

Answer 4

A2 F’(I1)

Question 5

How do firms finance purchases of K in period 1?

Answer 5

Borrow: D1F = I1

Borrow at IR r1

Question 6

Firms repayments

Answer 6

(1+r1)D1f

Question 7

Period 2 profits

Answer 7

Pi2 = A2F(I1) - (1+r1)D1f or I1 since D1F=I1

Question 8

Optimal investment

Answer 8

A2F'(I1) = (1+r1)
MPK = marginal cost of investment (constant)

Question 9

Impact of change in IR and efficiency on investment schedule

Answer 9

change in r1 = move along investment schedule

change in A2 = shift

Question 10

Period 1 profits

Answer 10

Pi1 = A1F(I0) - (1+r0)D0f

Question 11

Can firms effect P1 profits?

Answer 11

NO because all parameters exogenous

Question 12

How do households relate to firms?

Answer 12

Households OWN firms

Question 13

Period 1 BC household

Answer 13

C1 + (B1h - B0h) = r0B0h + Pi1

Question 14

Period 2 BC households

Answer 14

C2 + (B2h - B1h) = r1B1h + Pi2

Question 15

Optimality/transversatility condition

Answer 15

B2h=0

Question 16

Economy’s intertemporal resource constraint

Answer 16

C1 + C2/(1+r1) + I1 = (1+r0)B0* + A1F(I0) + A2F(I1)/(1+r1)

Question 17

B0* =

Answer 17

B1h - D1f

Question 18

small open economy means

Answer 18

r1=r*

Question 19

optimal consumption

Answer 19

U1(C1, C2)/U2(C1, C2) = (1+r1)
MRS = MC of C1
slope of IC = slope of BC

Question 20

TB1 =

Answer 20

TB1 = Q1 - C1 - I1

Question 21

CA1 =

Answer 21

CA1 = r0B0* + TB1

Question 22

TB2 =

Answer 22

TB2 = Q2 - C2 (I2 = 0)

Question 23

End of p1 investment (2 ways)

Answer 23

B1* = B0* + CA1

or B1* = (1+r0)B0* + TB1

Question 24

CA2 =

Answer 24

CA2 = r1B1* + TB2

Question 25

National savings =

Answer 25

S1 = Q1 + r0B0* - C1

where Q1 = A1 F(I0)

Question 26

3 effects of higher IR

Answer 26

1. SE: rise r1, fall C1
2. IE on household debt: rise r1, fall C1 for debtors (B0h<0); rise C1 for lenders (B0h>0)
3. IE on profits: rise r1, fall Pi2 = fall C1

Question 27

Which effect dominates? Therefore impact of IR on saving is…?

Answer 27

SE>IE
Therefore: higher r1 = lower C1 = higher S1
National savings rise

Question 28

What is a collateral constraint?

Answer 28

Firms can borrow at most k units in period 1:

D1f<=k

Question 29

Constrained equilibrium under collateral constraint

Answer 29

I1 = MIN{I1NC, k}

Where I1NC satisfies: A2F’(I1) = (1+r1)