Adam Smith Business School

Subject of Economics
Degrees of MA (Soc.Sci.) BAcc, BSc, LLB with Honours Economics
Degrees of MA (Soc.Sci.) BSc, LLB with Honours Business Economics
Degree Exam
Advanced Macroeconomics, ECON4040
Wednesday, 11 December 2019, 13:00-15:00

Please ensure that you write the course code (as above), your student ID, date of birth
and the number of the question that you have attempted on each answer sheet.

How to complete this exam:

• Students should answer ONE question from Section A and ONE question from Section
B.

Materials allowed:
• Calculators: Casio FX-83GT/Casio-83GT+, Casio FX-85GT/Casio FX-85GT+, Sharp
EL531WH, Aurora AX-582BL, Sharp EL-233SBBK/Sharp ELSI MATE EL-233S

Instructions to students:
• Both entry and exit to the examination hall will be at the absolute discretion of the
invigilator.
• No candidate will be permitted to leave within the first hour or the last half hour of this
exam.

Using exam answer sheets

•
•

• Always use a black pen.

• Complete personal information on all white sheets supplied before the exam begins.
• Use the standard character set, printed above, when hand writing in data boxes. E.g.
Student ID, Date of Birth, Question Number. Keep your characters inside the boxes.
• Use one white written answer sheet per question, using BOTH sides if required.
• For this exam, the required number of white answer sheets is TWO.
• Request yellow continuation sheets to continue writing answer if there is not enough
space on the white sheet.
• You must return all answer sheets to the invigilator even if you have not attempted all
questions.

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This page has been left blank for student notes – anything written here will not be marked.

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Section A

You must answer ONE question from this section, using ONE white answer sheet for
each question (all questions and sub questions are of equal weighting). If there is not
enough space on a white sheet, please raise your hand to request a YELLOW answer
sheet in order to continue your answer.

Question 1:
1. Consider the following utility function, time constraint and production func-
tion respectively:
u(c; x) = ln(c) + ! ln(x) (1)
l+x=1 (2)
f (l) = A (l) (3)
where u is utility; ln is the natural logarithm; c is consumption; x is leisure;
l is labour; and ! > 0 is the weight attached to leisure; A > 0 is neutral
technical change; and 0 < < 1 is the elasticity of output, y, with respect
to labour. Since capital has been excluded from the production function,
c = y = f (l).

1.1 Set up the optimisation problem for the central planner and derive the
equilibrium condition which states that the marginal product of labour,
@f (l) =@l, is equal to the marginal rate of substitution between con-
sumption and leisure, @u(c;x)
@x
= @u(c;x)
@c
. Provide an intuitive explanation
for both the problem setup and the result. [12.5%]

1.2 Derive and explain the analytical expressions for equilibrium l, y, c, x

and eu(c;x) , where e is the exponential operator. [12.5%]

1.3 Draw both the indi¤erence curve, implied by equation (1), and the pro-
duction function, implied by equation (3), in the (c : x) space. Provide
an economic interpretation for the point where the two functions are
tangential. [12.5%]

1.4 Using the indi¤erence curve and production function in the (c : x)

space, show and explain what happens to equilibrium c and x when
productivity, A, increases. [12.5%]

CONTINUED OVERLEAF
2 Consider the following representative agent model of goods-leisure choice:

u(c; n) = ln(c) + ln(x)

x=T n
(1)
y = An
c = y:

2.1 De…ne all variables and parameters in the above model and provide
an economic interpretation for each of the equations. Using the above
model, explain the optimisation problem undertaken by a social plan-
ner. For A = 1, T = 24 and = 0:5 …nd equilibrium values for n, x, c
and u. [12.5%]

2.2 Suppose that A doubles and all other parameters remain the same as
in sub-question (2.1). Find the new equilibrium values for n, x, c and
u and explain why they have changed. [12.5%]

2.3 Graphically decompose the changes, from the equilibrium in sub-question

(2.1) to the equilibrium in sub-question (2.2), into income and substi-
tution e¤ects. Fully explain your analysis. [12.5%]

2.4 In sub-questions (2.1) and (2.2), determine whether the average pro-
ductivity of labour, de…ned as y=n, exceeds, equals, or falls below the
marginal product of labour. Suppose that increases by 10% and all
other parameters remain the same as in sub-question (2.1). Find the
new equilibrium values for n, x, c and u and explain why they have
changed. [12.5%]

CONTINUED OVERLEAF
Section B

You must answer ONE question from this section, using a new white answer sheet (all
questions of equal weighting). If there is not enough space on a white sheet, please raise
your hand to request a YELLOW answer sheet in order to continue your answer.

3 Consider the following utility function, resource constraint, capital evolution

equation and production function respectively for a two-period model de…ned
over t and t + 1:
u(ct ; ct+1 ) = ln(ct ) + ln(ct+1 ) (1)
yt = ct + it (2)
kt+1 = (1 ) kt + it (3)
yt+1 = f (kt+1 ) = A (kt+1 )1 (4)
where u is utility; ln is the natural logarithm; ct is consumption in period t;
0 < < 1 is the rate of time preference; 0 1 is the depreciation rate;
yt is output in period t; it is investment in period t; kt+1 is capital in period
t + 1; A > 0 is neutral technical change; and 0 < 1 < 1 is the elasticity
of output, y, with respect to capital. Since labour has been excluded from
the production function, ct+1 = yt+1 = f (kt+1 ).

3.1 Assuming full depreciation of capital and that output at time t is ex-
ogenous and given, set up the optimisation problem for the central
planner and derive the equilibrium condition which states that the
marginal product of capital, @f (kt+1 ) =@kt+1 , is equal to the marginal
rate of substitution between consumption in time periods t and t + 1,
@u(ct ;ct+1 ) @u(ct ;ct+1 )
@ct
= @ct+1 . Provide an intuitive explanation for both the prob-
lem setup and the result. [12.5%]

3.2 Derive and explain the analytical expressions for equilibrium kt+1 , yt+1 ,
ct+1 , ct , and eu(ct ;ct+1 ) , where e is the exponential operator. [12.5%]

3.3 Draw both the indi¤erence curve, implied by equation (1), and the
production function implied by equation (4), in the (ct+1 : ct ) space.
Provide an economic interpretation for the point where the two func-
tions are tangential. [12.5%]

3.4 Using the indi¤erence curve and production function in the (ct+1 : ct )
space, show and explain what happens to equilibrium ct+1 and ct when
the exogenous goods endowment, yt , increases. [12.5%]

CONTINUED OVERLEAF
4 Consider a simple centralised two-period economy with logarithmic prefer-
ences over consumption in each period. Assume the following: (i) second
period consumption is valued less than in the …rst period; (ii) the exogenous
goods endowment in the …rst period can be either consumed or invested in
the form of capital; (iii) second period capital stock is equal to …rst period
investment since capital is assumed to fully depreciate between periods; and
(iv) production only occurs in the second period and is described by a de-
creasing return to scale function in the quantity of second period capital and
neutral technical progress.

4.1 Using 0 and 1 to denote the …rst and second periods respectively, set
up and explain the problem of the central planner and show that in
equilibrium, the marginal rate of substitution of consumption is equal
to the marginal product of capital. [12.5%]

4.2 Assuming an initial exogenous goods endowment of 100; a discount

rate of 0:98; an output to capital elasticity of 0:5; and a productivity
parameter of 12, calculate the central planner’s equilibrium allocations
for: (i) capital in the second period; (ii) consumption in both periods;
(iii) the savings rate; (iv) the consumption growth rate; and (v) utility. [12.5%]

4.3 Using the production function and an indi¤erence curve for this model,
graphically show and explain what happens to equilibrium consumption
in both periods when productivity rises. [12.5%]

4.4 Using the production function and an indi¤erence curve for this model,
graphically show and explain the e¤ect on consumption in both time
periods of an increase in the exogenous output endowment in the …rst
period. [12.5%]

Before your exam answers are collected:

Please ensure that you have written the course code (on the front of this exam
paper), your student ID, date of birth and the question number on each
answer sheet.

Put your exam answers together, keeping white and yellow answer sheets
together and in the correct order.

Do not place any other exam materials, including the exam paper, beside the
answer sheets.

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END OF PAPER