1

BMAK 2024
The Final Problem Set
Problem 1
An economy in the long run is described by the following Cobb-Douglas production function:

Yt = Ktα (At Lt )1−α

where 0 < α < 1.
Kt+1 = (1 − δ)Kt + It , 0 < δ < 1.
It = St − CAt
St = s · Yt , 0<s<1
CAt = m · Yt , 0<m<1
Lt+1 = (1 + n)Lt
At+1 = (1 + g)At . In the following question, m is assumed to be zero.
Kt
a) Define K̃t = At Lt , derive the capital-intensive form of the production.

b) Draw the Solow diagram, derive the growth rate of K̃t in the long run and explain the existence of a steady state level
of K̃ ∗ . Derive the formula of K̃ ∗ , which is the value of capital per effective work at the steady state.
c) If the economy is on the left of the steady state level K̃ ∗ , explain how the economy will move to the steady state.
d) What happens if the economy happens to be on the right of the steady state level of capital per effective worker. Please
provide an example of such a case in history?
Yt
e) Suppose that the economy is on the left of the steady state. Derive the growth rates of Yt , Kt , Lt .
Yt
f) Once the economy enters the steady state, what are the growth rates of Yt , Kt , Lt ?

g) Under the assumption of perfect competition, show that the income share of labor is (1 − α).
h) Explain the concept of the golden rule of saving and show that the saving rate dictated by the golden saving for this
economy is α. Provide the economic meanings to the golden rule of saving.
Yt
i) For the economy of Vietnam in 2020, n = 0.01, g = 0.02, δ = 0.03, α = 0.3, and s = 0.2. Suppose that Lt = 8000 and
that the economy is at the steady state. What is the level of technological progress A2020 ?
j) Starting from the steady state in question i), the government of Vietnam initiate a new set of policies to advocate for
higher savings, raising the saving rate of the economy to s2 = 0.3 from 2020 onward. Please explain the economic
Yt
rationale for such a policy move. Describe the transition path for Yt , Kt , Lt
, AKt Lt t , AYt L
t
t
, consumption and investment
per worker, per effective worker as the economy moves from the old to the new steady state.
Yt
k) Compute the value of Lt for Vietnam in 2021, 2022, and 2023.
For the next questions, we assume that m ̸= 0,
l) Derive the steady state level of capital per effective worker at the steady state. Provide the economic reasoning for
your finding.

Problem 2
An economy under fixed prices (for which foreign variables are exogenous) is described by the following model:
Y = DD = C + I + G + T B;
C = C0 + Cy · (Y − T ) − Cr · r;
I = I0 − Ir · r;
G = G0 + Gy (Ȳ − Y );
T B = T B0 + T Bex · (Y ∗ − T ∗ ) − T Bim · (Y − T ) + T Bϵ · ϵ;
ϵ = ϵ0 − ϵnr (r − r∗ )  o
r = max 0, r̄M P + ϕy · Y Ȳ−Ȳ



+ r̄RP − ry · Y − Y ZLB · I Y < Y ZLB .

When numerical calculations are asked for, assume the following parameter values: C0 = 1.6; Cy = 0.6; Cr = 3; T =
2.5; I0 = 3.0; Ir = 15; G0 = 2.8; Gy = 0.1; T B0 = 0; T Bex = 0.1; Y ∗ = 100; T ∗ = 30; T Bim = 0.15; T Bϵ = 1; ϵ0 = 1; ϵr =
1; r∗ = 0.03; r̄M P = 0.02; ϕy = 1; Ȳ = 15; r̄RP = 0.01; ry = 0.005.
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a) Present the two defining assumptions of the economy in the short run.
n  o
b) Provide the economic interpretation to the interest rate equation r = max 0, r̄M P + ϕy · Y Ȳ−Ȳ + r̄RP − ry ·



Y − Y ZLB · I Y < Y ZLB .

c) In the normal business cycle, provide the economic interpretation for ϕy .

d) Derive the IS curve. Please explain why the IS curve is downward sloping.

e) Please provide the economic interpretation for C0 .

f) Please provide the economic rationale on how the slope of the IS curve depends on Cr , and Gy .

g) Compute the short-run macroeconomic outcomes.

h) Due to the covid-19 pandemic, international trade flows are disrupted. The trade balance of this economy is negatively
affected, represented by a reduction of 0.3 in T B0 . Compute the impacts of this shock. Make sure that you decompose
the effects into the Keynesian multiplier and crowding in/out effects.

i) Starting from the short-run outcome in Question h), the government introduces a universal income program that gives
each household an income of $3, 000. The effects of this measures is represented by an increase in C0 by 0.3 Compute
the impacts of this counter-crisis measure. Make sure that you decompose the effects into the Keynesian multiplier and
crowding in/out effects. Is the measure effective. Please comment on the cooperation between the monetary and fiscal
policies in this case.

j) Starting from the short-run outcome in Question h), the commercial bank system increases the autonomous risk
premium component rRP¯ to 0.03. Compute the macroeconomic outcomes. Is the economy still in the normal business
cycle. Please decompose the impact of this shock into the Keynesian, monetary policy, and risk premium effects.

k) Starting from the short-run outcome in Question i), the government introduces an investment subsidy program that
increases I0 to 3.25. Please decompose the effect of this counter-crisis measures into the Keynesian multiplier, monetary
policy, and risk premium effects. Please comment on the cooperation between the monetary and fiscal policies in this
case.

l) Starting from the short-run outcome in Question j), the central starts buying long-term bonds and conducting forward
guidance, assuring commercial banks and economy that the central bank interest rate will remain low for an extended
period of time. The commercial bank systems, therefore, lowers the exogenous risk premium to 0.02. Please decompose
the impact of this change into monetary policy, and risk premium effects.

Suppose that a severe pandemic has broken out and the home country has to consider lock-down measures to stop the
spreading of an unknown virus. This led to the following modifications in the extended IS-TR framework:
C = (1 − τ ) · (C0 + Cy · (Y − T ) − Cr · r
I = (1 − τ ) · (I0 + Ir · r)
T B = T B0 + (1 − τ ) · T Bex · (Y ∗ − T ∗ ) + T Bim · (Y − T ) + T Bϵ · [ϵ0 − ϵr · (r − r∗ )]
rnM P = r0M P + ϕz (z − z̄).
All other element of the extended IS-TR framework remain unchanged.

m) Derive the equation of the IS curve.

n) Suppose that τ = 0.15. Compute the short-run macroeconomic outcomes of this economy.

Problem 3
On the extended AS-AD model: An economy with sticky prices (for which foreign variables are exogenous) is described by
the following model:

Yt = DDt = Ct + It + Gt + T Bt ;
Ct = C0 + Cy · (Yt − T ) − Cr · rt ;
It = I0 − Ir · rt ;
Gt = G0 − Gy · (Ȳ − Y );
T Bt = T B0 + T Bex · (Y ∗ − T ∗ ) − T Bim · (Yt − T ) + T Bϵ · ϵt ;
∗
ϵt = ϵ0 − ϵr · (r
n t − rt )   o
Y −Ȳ
RtM P = max 0, r̄M P + π e + ϕy · Ȳ
+ ϕπ (πt − π T ) ;
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rt = RtM P − πe + r̄RP
 − ry · Yt − Yt
ZLB
|πt · I Yt < YtZLB |πt ;
πt = π e + ω · YtȲ−Ȳ + st .
π e = πt−1 .
When numerical calculations are asked for, assume the following parameter values: C0 = 1.6; Cy = 0.55; Cr = 3; T = 2.5; I0 =
3.25; Ir = 15; G0 = 2.8; Gy = 0.1; T B0 = 0; T Bex = 0.1; Y ∗ = 100; T ∗ = 30; T Bim = 0.15; T Bϵ = 1; ϵ0 = 1; ϵr = 1; r∗ =
0.03; r̄M P = 0.02; ϕy = 1; Ȳ = 15; r̄RP = 0.01; π e = 0.02; ϕπ = 2; ϕy = 1; π T = 0.02; ω = 0.05; s = 0; ry = 0.007.

a) Provide the economic

n interpretation
 for the interest rateosetting process:
RtM P = max 0, r̄M P + π e + ϕy · Y Ȳ−Ȳ + ϕπ (πt − π T ) ;,
and


rt = RtM P − π e + r̄RP − ry · Yt − YtZLB |πt · I Yt < YtZLB |πt

In the following questions, the economy is assumed to be in the normal business cycle.

b) Derive the AD curve and provide the economic rationale for the AD curve to be downward sloping.
c) Provide the economic rationale for the AS curve to be upward sloping in the medium run.
d) Compute the macroeconomic outcomes for this economy.
e) Suppose that the economy is currently operating in period 2. Due to the Covid-19, income in foreign economies reduces
to 5 in period 2. Please compute the macroeconomic outcomes after this exogenous shock.
f) Compute the macroeconomic outcomes in periods 3 and 4 following the shock in Question e).
g) Starting from question e), the government introduces strong counter-crisis measures, increasing G0 to 4 in period 2 to
rescue the economy. Compute the medium macroeconomic outcomes in this case. Please comment on the effects of the
counter-crisis measures.

In the following questions, the economy is assumed to be in the deep medium run crisis:
h) Derive the AD curve in the deep crisis scenario. Provide the economic rationale for the AD curve to be upward sloping.
i) Derive the level of inflation that causes the central bank to lower it interest rate to 0. Prove that this level of inflation
does not depend on the level of output, given the parameters.

j) Starting in period 2, and giving the information in Question e), the commercial bank system raises the exogenous risk
components to 0.05. Is the economy in the deep crisis scenario? Compute the medium macroeconomic outcomes.
k) Starting from the situation in Question h), the government introduces strong counter-crisis measures, increasing G0 to
4 in period 2 to rescue the economy. Compute the medium macroeconomic outcomes in this case. Is the economy still
in the deep crisis?
Suppose that the economy in the medium run is at the long-run equilibrium, and a severe pandemic has broken out and
the home country has to consider lock-down measures to stop the spreading of an unknown virus. This led to the following
modifications in the extended IS-TR framework:
C = (1 − τ ) · (C0 + Cy · (Y − T ) − Cr · r
I = (1 − τ ) · (I0 + Ir · r)
T B = T B0 + (1 − τ ) · T Bex · (Y ∗ − T ∗ ) + T Bim · (Y − T ) + T Bϵ · [ϵ0 − ϵr · (r − r∗ )]
rnM P = r0M P + ϕz (z −  z̄). 
Yt −Ȳ
πt = π e + (1 + τ ) · ω · Ȳ
+ st . All other element of the extended IS-TR framework remain unchanged.

m) Derive the equations of the AS and AD curves.

n) Suppose that τ = 0.15. Compute the medium-run macroeconomic outcomes of this economy.