Final Assessment Guidelines
ECON 6002
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The final assessment will be a short-release assignment for 120 minutes (+15 minutes
upload time) starting at 6pm (AEST) on Monday, 22 May. The short-release assign-
ment will be open book. You will need to upload your answers via the Canvas assign-
ment by 8:15pm (AEST). Because it is a short-release assignment, no late submissions
will be accepted.
Material Covered and Expectations:
1. The final assessment will cover material from the whole course, although focusing mostly on
material since the midterm assessment. Anything covered in class, in the tutorials, or in the
problem sets is potentially assessable.
2. You will be provided with relevant formulas such as production functions to be used in
answering a question (see questions below for examples of what sort of material will be
provided and what you might be assumed to know).
3. You will be expected to understand and interpret the “economics” behind any equations
provided.
4. In answering algebraic/numerical questions, be precise, showing all of the steps, and indicate
if you are making any assumptions along the way. Report answers to 2 decimals (unless
otherwise stated) and put a box around your final answer.
5. Answers must be in your own words. Use quotations when referencing textbook, lecture, or
tutorial material.
6. You must complete the assessment on your own. Do not collaborate in any way.
7. Questions will be personalized based on your student ID. Specifically, you will be asked to
write out your student ID number, which will be cross-checked with your submission and
used to provide parameter values or assumptions when solving certain questions.
8. You will be given 15 minutes after the 2 hour assignment to scan/convert your answers to a
pdf and upload under the upload assignment link for the final assessment assignment link.
9. I will not post solutions for the questions below because closely related questions may show up
in the assignment. You should be able to come up with your own solutions using the lecture
slides, textbook, tutorial solution videos, and answer key for the problem set. Doing so will
be good preparation for the assignment. But it is not sufficient as there will be different
questions.
Example Questions:
1. Consider the Romer model and note the equilibrium output (per capita) growth is
max
{
(1−φ)2
φ BL¯− (1− φ)ρ, 0
}
.
(a) Why, in economic terms, would the output growth rate increase in (1− φ), B, and L¯?
(b) The Romer model is a microfounded model of endogenous growth. Explain why endo-
genizing growth in the Romer model requires deviation from the assumption of perfect
competition?
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(c) Provide an empirical example that supports the importance of population growth for
economic growth.
(d) Why do Canada and the United States have similar growth despite very different pop-
ulations?
(e) Explain in words why the decentralized equilibrium in the Romer model is socially
suboptimal.
2. Consider a simple Taylor rule with an inflation target of zero: it = r¯ + φpipit + φyy˜t, where it
is the nominal interest rate, r¯ > 0 is the natural real interest rate, pit is inflation, and y˜t is
the output gap. The aggregate demand and supply equations are given by y˜t = −β(rt−1 −
r¯) + ρy˜t−1 + εDt and pit = pit−1 + αy˜t + εSt , where εDt and εSt are demand and supply shocks,
respectively. The relationship between it and rt is given by the Fisher identity (assuming
expected inflation is equal to current inflation): rt = it−pit. All parameters (r¯, φpi, φy, β, ρ, α)
are > 0. Further, assume that the following parameters (α, β, ρ, φy < 1). Suppose that there
is one-time 10% supply shock at time t = 0 so that εS0 = 0.1. There is no further demand or
supply shock after t = 0. Assume that prior to t = 0, the economy was in steady state with
i = r¯, pi = 0, y˜ = 0, and r = r¯.
(a) Solve for inflation and the output gap at t = 0 and 1 (i.e., pi0, pi1, y˜0, y˜1) as functions of
model parameters (or compute the exact values if available).
(b) Suppose that φpi ≤ 1. Show that y˜1 ≥ y˜0 ≥ 0 and pi1 ≥ pi0 > 0.
(c) Suppose that φpi > 1. Show that it is possible to stabilize inflation after only one period
(i.e., pi1 = 0). At what value of φpi would this occur?
(d) What can you say about the role of the value of φpi for inflation stabilization? But what
is the cost of a higher ratio of φpi/φy?
3. Consider the delegation problem under discretionary policy. Suppose social loss minimization
implies pi = pi∗ + b
a+b2
(y∗ − yflex) + b2
a+b2
(pie − pi∗), while loss minimization for a “hawkish”
central banker with a′ > a implies pi = pi∗ + b
a′+b2 (y
∗ − yflex) + b2
a′+b2 (pi
e − pi∗). Let pi∗, piEQ,
and piEQ
′
be equilibrium inflation under rule-based policy with commitment, discretionary
policy without delegation, and discretionary policy with delegation, respectively.
(a) Show, mathematically, that pi∗ < piEQ′ < piEQ.
(b) Show the result in (a) graphically. You should compute the precise slopes and intercepts
(i.e., when pie = 0) for both discretionary policies (with and without delegation).
(c) What value of a′ would imply that the equilibrium inflation rate under discretionary
policy with delegation is equal to the inflation rate under rule-based policy with com-
mitment? Would this be a good value if the true social loss function (i.e., the loss
function corresponding to household preferences) has the relative weight on inflation
stabilization equal to a? How does your answer depend on assumptions about shocks
hitting the economy?
(d) Suppose the central banker’s true preferences regarding inflation match the social welfare
function (i.e., the parameter on squared inflation deviations in the loss function is a < a′),
but private sector agents believe the central banker is “hawkish” with parameter a′ when
inflation is determined. Is social welfare higher if the public is wrong about the central
banker’s preferences or if the central actually is “hawkish”, as assumed in parts (a)-(c).
Explain your reasoning.
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4. Consider the “Q” model of investment with adjustment costs. Equilibrium suggests that
capital K(t) evolves as K˙(t) = C ′−1(q(t) − 1) (normalizing the number of firms N = 1
and assuming no depreciation), while the marginal value of capital, q(t) evolves as q˙(t) =
rq(t) − pi(K(t)), where r is the real interest rate. Note that the capital adjustment cost
function, C(I(t)) satisfies C(0) = 0, C ′(0) = 0, and C ′′(·) > 0 and the real profit function,
pi(K(t)), satisfies pi′(·) < 0. Assume the transversality condition limt→∞e−rtq(t)κ(t) = 0,
where κ(t) is the representative firm’s capital stock.
(a) Draw the phase diagram for this model, explaining the location of the saddle path.
(b) Use the phase diagram to show what happens given a sudden permanent drop in demand
for output in a given industry. Explain what happens to q and K in that industry. What
happens to the relative price of the industry’s output, as well as profits and the market
value of capital, both on impact and over time?
(c) Compare your results in part (b) to what would happen if the drop in demand were only
temporary. Does q jump by more or less than in the case of a permanent drop? Why
can’t there be any anticipated jump in q after the initial fall?
(d) Comparing the results for parts (b) and (c), what do they imply about the effects of
future changes in output on current investment for this industry? (Hint: in which case
is the accelerator effect larger?)