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    Macroeconomics 1 Problem Set 1

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    Taib Muffak
    This document contains an analytical problem set in macroeconomics with 4 exercises: 1) Show that the Cobb-Douglas and CES production functions satisfy properties of neoclassical production functions. 2) Define the elasticity of substitution between capital and labor using a CES production function. Calculate the elasticity and capital's share of income. 3) Present profit maximization and FOC conditions for a firm using a CES production function. 4) Prove that the CES production function converges to the Cobb-Douglas function as the substitution parameter approaches 1.

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    Macroeconomics 1 Problem Set 1

    Uploaded by

    Taib Muffak
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    This document contains an analytical problem set in macroeconomics with 4 exercises: 1) Show that the Cobb-Douglas and CES production functions satisfy properties of neoclassical production functions. 2) Define the elasticity of substitution between capital and labor using a CES production function. Calculate the elasticity and capital's share of income. 3) Present profit maximization and FOC conditions for a firm using a CES production function. 4) Prove that the CES production function converges to the Cobb-Douglas function as the substitution parameter approaches 1.

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    This document contains an analytical problem set in macroeconomics with 4 exercises: 1) Show that the Cobb-Douglas and CES production functions satisfy properties of neoclassical production functions. 2) Define the elasticity of substitution between capital and labor using a CES production function. Calculate the elasticity and capital's share of income. 3) Present profit maximization and FOC conditions for a firm using a CES production function. 4) Prove that the CES production function converges to the Cobb-Douglas function as the substitution parameter approaches 1.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    15 views3 pages

    Macroeconomics 1 Problem Set 1

    Uploaded by

    Taib Muffak
    This document contains an analytical problem set in macroeconomics with 4 exercises: 1) Show that the Cobb-Douglas and CES production functions satisfy properties of neoclassical production functions. 2) Define the elasticity of substitution between capital and labor using a CES production function. Calculate the elasticity and capital's share of income. 3) Present profit maximization and FOC conditions for a firm using a CES production function. 4) Prove that the CES production function converges to the Cobb-Douglas function as the substitution parameter approaches 1.

    Copyright:

    © All Rights Reserved
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    of 3

    Macroeconomics I

    Analytical Problem Set # 1


    Marti Mestieri Ferrer, UPF, BSE

    This is due Thursday January 21st

    Exercise # 1: Neoclassical production functions

    (a) Show that the Cobb-Douglas production function:

    F (K, L) = K α L1−α (1)

    is a Neoclassical production function.

    (b) Euler’s Theorem: A version of the Euler’s Theorem is represented by the following
    statement. Suppose that the function f (x, y) is continuously differentiable. Then,
    f is positive homogeneous of degree 1 if and only if

    fx (x, y)x + fy (x, y)y = f (x, y)

    where fi (x, y) = ∂f (x,y)


    ∂i . Show that the theorem applies to the case of a Cobb-Douglas
    production function.

    (c) Consider a more general class of production functions known as “Constant Elasticity
    of Substitution (CES)” production functions:

    σ
    σ−1 σ−1 σ−1
    Y = F (K, L) = [αK σ + (1 − α)L σ ] (2)

    Prove that this general type of functions satisfy the first two properties of Neo-
    classical production functions: (i) constant returns to scale and (ii) Positive and
    diminishing marginal returns. Ignore the Inada conditions.

    1
    HINTS:

    • The proof for -(i) constant returns to scale- is easy


    • To make calculations simpler when proving (ii) Positive and diminishing marginal
    returns (FKK (K, L) < 0), keep the expressions as compact as possible. In par-
    Y
    ticular, try to get final expression for FKK (K, L) that depends on α, σ, K ,
    FK (K, L), and F (K, L). You can then make use of Euler’s theorem.

    (d) Show that the CES production function converges to the Cobb-Douglas function
    when σ → 1
    HINT: follow the following steps

    • Take natural logs on the CES production function


    • Take the constant that multiplies what it’s inside the log and invert it so you
    can write an expression like:

    ln of something that depends on α, σ, K, and L


    lnY =
    something that depends on σ
    • Your goal is to compute the limit of that expression when σ → 1. In order to
    do so, apply the l’Hopital’s rule, which says the following:

    f (x) f ′ (x) f (x)


    if lim exists ⇒ lim ′ = lim
    x→c g(x) x→c g (x) x→c g(x)

    • Define your numerator as f (x) and your denominator as g(x), where x = σ


    • Take the derivatives of these two functions with respect to σ. You will have to
    make use of the following properties of derivatives:

    ∂lnh(x) h′ (x)
    = (3)
    ∂x h(x)
    ∂a h(x)
    = ah(x) ln(a)h′ (x) (4)
    ∂x

    • You are almost done. Just take the limit:

    f ′ (σ)
    lim (5)
    σ→1 g ′ (σ)

    2
    • Most of the terms should equal one and cancel out. You should get a final
    expression like this:

    f ′ (σ)
    lim = lim lnY = αlnK + (1 − α)lnL (6)
    σ→1 g ′ (σ) σ→1

    • Taking the exponential on both sides will conclude the proof.

    Excersise # 2: Elasticity of substitution between labor and capital

    Let’s define the elasticity of substitution between capital and labor as:

    ∂ln ( K
    L
    )
    ϵ≡ (7)
    ∂ln ( wr )
    where w and r are the prices of labor and capital respectively.

    (a) Assume that a representative firm producing in perfect competition has access to
    the following CES production function:

    σ
    σ−1 σ−1 σ−1
    Y = F (K, L) = [αK σ + (1 − α)L σ ] (8)

    (i) Define the profit maximization problem of the firm


    HINT: In perfect competition firms take all prices as given (P , w, and r).
    Normalize P to be equal to 1.
    (ii) Compute the FOC conditions with respect to labor and capital
    (iii) Combine the two FOC and calculate ϵ
    (iv) Use the FOC of capital to compute the share of capital in total income defined
    as:

    rK
    (9)
    Y
    How does this change when r increases? What parametrization would make
    the evolution of PrKY consistent with the Kaldor fact that states that the income
    share of capital should be constant over time?
    HINT: This relationship depends on the value of σ. Remember that σ can take
    any value as long as σ > 0

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