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Economics 2010d
Spring 2014
Problem Set 2
3. Take the simple RBC model presented in Lecture 3. The budget constraint assumes
that people know they cannot invest in capital, since the stock of capital is fixed. But
this is not quite right if individuals are atomistic, since each one thinks she can buy as
much capital as she wants at the going price. (However, the aggregate capital stock is
still fixed at K , so aggregate investment must always be zero.)
a. Modify the budget constraint to allow for purchases of capital as well as riskless
bonds. Let the time-t price of capital relative to output be qt. The owner of a unit
of capital gets paid R, where R is the marginal product of capital. Capital needs to
be bought one period before any returns are received (one unit of capital
purchased at time t yields the owner Rt+1).
b. What is the Euler equation for consumption if foregone consumption
is used to purchase capital, which is held for one period?
c. Is there a connection between the rate of return on capital, R, and the
riskless interest rate r? What is it?
d. In equilibrium, is the price of capital relative to output, qt always equal to 1, as in
the standard Ramsey model? Explain why or why not.
Due February 10
Economics 2010d
Spring 2014