Seminar 4

I. Inequality and growth with incomplete credit markets

Consider a simple economy with two agents L and H with initial endowment a_L and a_H (a_L <a_H). Time is discrete and for simplicity both agents save a constant share s of their earnings for the next period.

1. Both agents has a production technology y=f(k) where k is capital invested (they always work one unit of labor), and the production function has standard properties f¡¯>0, f¡¯¡¯<0.
   Consider first the case where there is a credit market. If both agents try to maximize current period production, show that L would want to borrow from H and how this would improve efficiency.
2. Assume now that there are frictions in the credit market. For simplicity, we simply say that borrowing and lending is impossible. Show that this reduces current period aggregate production and aggregate savings relative to what you could derive in question 1). What happens to next period¡¯s production and savings relative to the scenario in question 1)?
3. Show that there is a steady state equilibrium, and explain how it depends on the initial endowment a_L and a_H.
4. Consider finally a case where production can be done using two different technologies. In a ¡°traditional¡± sector, production is f_t(k)=ak. The ¡°modern¡± sector is more productive but requires a fixed cost F: f_m(k)=bk-F where a<b.
   Study the effect of inequality, i.e. the differential between a_L and a_H, and how it depends on the value of F and whether a<1/s or not.

II. The empirics of inequality and growth (from the Exam 2015)

1. Explain the challenges of empirically investigating the causal effect of inequality on growth.

2. How does Easterly(2007) overcome these?

III. Politics of fear (from the Exam 2015)

Explain Padr¨® i Miquel¡¯s (2007) explanation for how it is possible to sustain politics that are bad to everybody but a tiny elite in divided societies. Be as explicit as possible on how he goes forth to model these questions. However,you do not need to formally solve the model.