Assignment 3 Economics 202-01 Macroeconomic Theory I Question 1 Suppose we allow for installation costs, the utility function and production function are given by U(ct) = ln ct (1) yt = F(kt) = Ak α t (2) In addition, the resource constraint and capital accumulation are given by yt = ct + ( 1 + φ 2 it kt ) it and (3) 4kt+1 = it − δkt, (4) where φ ≥ 0. (a) Write the First Order Conditions for consumption, capital, investment, and Lagrange multipliers for the optimal solution. (b) Derive the equation for Tobin’s q. (c) Using (a) and (b), derive the Euler equation in terms of Tobin’s q, capital, and con- sumption. (c) Determine the steady state levels for Tobin’s q, capital, investment, and consumption. (d) Determine the effects of a permanent productivity increase (i.e. 4A > 0). Question 2 Suppose we allow for technological progress, the utility and production functions are given by U(Ct) = ln Ct and (5) Yt = (1 + µ) tKαt N 1−α t , (6) where µ > 0. In addition, capital accumulation is given by 4Kt+1 = It − δKt. (7) 1 (a) Write the First Order Conditions for consumption, capital, labor, and Lagrange mul- tiplier for the optimal solution . (b) Derive the Euler equation. (c) Discuss the issues with steady-state optimal growth paths for consumption, capital and output. (d) Derive the per capita production function, yt = F(kt). [Note: yt = Yt Nt and kt = Kt Nt denote per capita output and capital in period t, respectively] 2 Part III: Business and Society Chapter 6: Consumers Chapter 7: The Environment * This multimedia product and its contents are protected under copyright law. The following are prohibited by law: • any public performance or display, including transmission of any image over a network; • preparation of any derivative work, including the extraction, in whole or in part, of any images; • any rental, lease, or lending of the program. Chapter Six: Consumers * * OverviewChapter Six examines the following topics:Product safety, legal liability, and regulationResponsibilities of business to consumers concerning product quality, prices, labeling, and packagingDeceptive advertising and the FTC“Reasonable” vs. “ignorant” consumer standardsThe social desirability of advertising, free speech, and consumer needs Moral Issues in Business Chapter 6 * IntroductionWith the sale of goods to the public comes responsibility on the part of the manufacturer and advertiser. Government has some responsibility to protect the public from hazardous or mislabeled goods. What responsibilities do companies have toward their consumers? How can goods be promoted while respecting the choices of individuals? Moral Issues in Business Chapter 6 * “Wigand revealed in a 60 Minutes interview that his employer knew nicotine was addictive and intentionally manipulated the tobacco content of its cigarettes to increase the amount of nicotine they delivered.” * Product SafetyBusines ...

1. Assignment 3
Economics 202-01
Macroeconomic Theory I
Question 1
Suppose we allow for installation costs, the utility function and
production function are given
by
U(ct) = ln ct (1)
yt = F(kt) = Ak
α
t (2)
In addition, the resource constraint and capital accumulation are
given by
yt = ct +
(
1 +
φ
2
it
kt

2. )
it and (3)
4kt+1 = it − δkt, (4)
where φ ≥ 0.
(a) Write the First Order Conditions for consumption, capital,
investment, and Lagrange
multipliers for the optimal solution.
(b) Derive the equation for Tobin’s q.
(c) Using (a) and (b), derive the Euler equation in terms of
Tobin’s q, capital, and con-
sumption.
(c) Determine the steady state levels for Tobin’s q, capital,
investment, and consumption.
(d) Determine the effects of a permanent productivity increase
(i.e. 4A > 0).
Question 2
Suppose we allow for technological progress, the utility and
production functions are given
by
U(Ct) = ln Ct and (5)
Yt = (1 + µ)
tKαt N
1−α
t , (6)

3. where µ > 0. In addition, capital accumulation is given by
4Kt+1 = It − δKt. (7)
1
(a) Write the First Order Conditions for consumption, capital,
labor, and Lagrange mul-
tiplier for the optimal solution .
(b) Derive the Euler equation.
(c) Discuss the issues with steady-state optimal growth paths for
consumption, capital
and output.
(d) Derive the per capita production function, yt = F(kt). [Note:
yt =
Yt
Nt
and kt =
Kt
Nt
denote per capita output and capital in period t, respectively]
2

4. Part III: Business and Society
Chapter 6: Consumers
Chapter 7: The Environment
*
This multimedia product and its contents are protected under
copyright law. The following are prohibited by law:
• any public performance or display, including transmission of
any image over a network;
• preparation of any derivative work, including the extraction,
in whole or in part, of any images;
• any rental, lease, or lending of the program.
Chapter Six:
Consumers
*
*
OverviewChapter Six examines the following topics:Product
safety, legal liability, and regulationResponsibilities of business

5. to consumers concerning product quality, prices, labeling, and
packagingDeceptive advertising and the FTC“Reasonable” vs.
“ignorant” consumer standardsThe social desirability of
advertising, free speech, and consumer needs
Moral Issues in Business
Chapter 6
*
IntroductionWith the sale of goods to the public comes
responsibility on the part of the manufacturer and advertiser.
Government has some responsibility to protect the public from
hazardous or mislabeled goods. What responsibilities do
companies have toward their consumers? How can goods be
promoted while respecting the choices of individuals?
Moral Issues in Business
Chapter 6
*
“Wigand revealed in a 60 Minutes interview that his employer
knew nicotine was addictive and intentionally manipulated the
tobacco content of its cigarettes to increase the amount of
nicotine they delivered.”

6. *
Product SafetyBusiness’s general responsibility for product
safety: The complexity of an advanced economy and the
necessary dependence of consumers on business to satisfy their
many wants increase business’s responsibility for product
safety.
Moral Issues in Business
Chapter 6
*
Product SafetyThe legal liability of manufacturers: The 1916
MacPherson vs. Buick Motor Car case expanded the liability of
manufacturers for injuries caused by defective products. Prior to
that case, consumers could recover damages only from the
retailer of the defective product. The MacPherson case replaced
the older caveat emptor (“let the buyer beware”) doctrine of
consumer-seller relationship with a due care one.
Moral Issues in Business
Chapter 6
*

7. Product SafetyStrict product liability: The MacPherson case
still left the injured consumer with the burden of proving that
the manufacturer had been negligent.Negligence is difficult to
prove.A product might be unsafe despite the manufacturer’s
having tried to exercise caution.
Moral Issues in Business
Chapter 6
*
Product SafetyStrict product liability: In the 1960s, legal
thinking became dominated by the doctrine of strict product
liability, based on:Henningsen vs. Bloomfield Motors
(1960)Greenman vs. Yuba Power Products (1963) This holds the
manufacturer responsible for injuries suffered as a result of
defects in the product, regardless of whether the manufacturer
was negligent.
Moral Issues in Business
Chapter 6
*
Product SafetyGovernment safety regulation: In 1972, Congress
passed the Consumer Product Safety Act.It empowered the

8. Consumer Product Safety Commission (CPSC) to protect the
public against “unreasonable risks of injury associated with
consumer products.”The CPSC aids consumers in evaluating
product safety, develops uniform standards, gathers data,
conducts research, and coordinates product safety laws (local,
state, federal) and enforcement.
Moral Issues in Business
Chapter 6
*
Product SafetyEconomic costs: Safety regulations benefit
consumers but raise the price of products – critics worry that
the expense is not always worth it.Consumer choice: Consumers
may dislike some mandated safety technology – but in other
cases safety regulations may prevent individuals from choosing
to purchase a riskier, though less expensive, product.
Moral Issues in Business
Chapter 6
*
Product SafetyLegal paternalism: The idea that the law may
justifiably be used to restrict the freedom of individuals for
their own good. Some product safety affects not just consumers
who purchase products but also third parties. In the increasingly

9. complex consumer world, the assumption that consumers know
their own interests better than anyone else is doubtful.
Paternalistic regulation may infringe individual autonomy but
bring more gain in social welfare.
Moral Issues in Business
Chapter 6
*
Product SafetyHow effective is regulation? Regulatory agencies
(FDA, CPSC) often succeed in protecting interests of consumers
and stressing business responsibility. Regulation, however, is
not always effective.Public opinion, media attention, pressure
from consumer advocacy groups, and the prospect of class-
action lawsuits are also effective in forcing companies to take
product safety seriously.
Moral Issues in Business
Chapter 6
*
Product SafetySelf-regulation: Businesses generally prefer self-
regulation, competition, and voluntary safety standards set by
their own industry. But, self-regulation can easily subordinate
consumer interests to profit making when the two goals clash.
Under the guise of self-regulation, businesses can end up

10. ignoring or minimizing their responsibilities to consumers.
Moral Issues in Business
Chapter 6
*
Product SafetyAutomobile safety: The auto industry has a long
and consistent history of fighting against safety regulations.
Some examples:The industry successfully lobbied the federal
government to delay the requirement that cars be equipped with
air bags or automatic seat belts.In the late 1990s, the industry
denied that car passengers are at a greater risk of serious injury
or death caused by collisions with pickups or SUVS than with
automobiles.
Moral Issues in Business
Chapter 6
*
The Responsibilities of BusinessProtecting the consumer
requires more than just obeying the law. It also requires
business to: Give safety the priority warranted by the product
Abandon the misconception that accidents result solely from
consumer misuse Monitor closely the manufacturing process
itself. Review the safety implications of their marketing and
advertising strategies Provide full details about product

11. performance Promptly investigate consumer complaints
Moral Issues in Business
Chapter 6
*
The Responsibilities of BusinessSome businesses respond
quickly to suspected hazards. Examples of two successful
companies:JCPenney and Burning Radios: It withdrew an entire
line of defective radios, ran national ads to inform the public,
and offered immediate refunds.Johnson Wax and Fluorocarbons:
It withdrew all its aerosol fluorocarbon products worldwide
after studies showed the released chemicals were depleting the
earth’s fragile ozone layer.
Moral Issues in Business
Chapter 6
*
Other Areas of Business ResponsibilityProduct quality:
Warranties are obligations for product quality and reliability
that sellers assume.There are two kinds of warranty:Express:
The claim that a seller explicitly statesImplied: The claim,
implicit in any sale, that a product is fit for its ordinary,
intended use, called the implied warranty of merchantability –
it’s not a promise that the product will be perfect but a

12. guarantee that it will be of passable quality
Moral Issues in Business
Chapter 6
*
Other Areas of Business ResponsibilityPricing: For many
consumers, higher prices mean better products, so sellers raise
prices to give the impression of superior quality or exclusivity –
but higher prices do not always mean better
quality.Manipulative pricing: Consumers are misled by prices
that conceal a product’s true cost – this trickery or manipulation
raises moral questions about business’s view of itself and its
role in the community.
Moral Issues in Business
Chapter 6
*
Other Areas of Business ResponsibilityPrice fixing: The effort
to control a given market and conspire to force consumers to
pay artificially high prices. There are two kinds of price fixing:
Horizontal: Occurs when competitors agree to adhere to a set
price schedule (not to cut prices below a certain minimum, or to
restrict price advertising or the terms of sales or
discounts).Vertical: Takes place when manufactures and

13. retailers, as opposed to direct competitors, agree to set prices.
Moral Issues in Business
Chapter 6
*
Other Areas of Business ResponsibilityPrice gouging: A seller’s
exploitation of a short-term situation by raising prices when
buyers have few purchase options for a much-needed
product.Thought generally viewed as unethical, there is
disagreement about what it is and whether all instances of it are
wrong. The question “What is a fair price?” is not an easy one
to answer – one must consider the costs of material and
production, operating and marketing expenses, profit margin,
etc.
Moral Issues in Business
Chapter 6
*
“In May 2008, American Airlines, one of the industry’s major
carriers, started imposing a checked-bag fee. Other airlines
promptly followed suit. What are consumers to think when a
policy instituted by one company is promptly adopted by
others?”

14. *
Other Areas of Business ResponsibilityLabeling and packaging:
Business is responsible to provide accurate, clear, and
understandable product information that meets consumer
needs.Product labels often fail to do thisPackage shape, terms,
and quantity surcharges may also mislead shoppersMoral
conduct begins by providing consumers with what they need to
know to make informed product choices.
Moral Issues in Business
Chapter 6
*
Deception and Unfairness in AdvertisingThe goal of
advertising: Advertising provides little useful information about
goods and services, but has as its goal to persuade us to buy
certain ones.Deceptive techniques: Providing frank product
information is not always the most effective way to sell
something – advertisers are tempted to misrepresent and deceive
by exploiting ambiguity, concealing facts, exaggerating, and
using psychological appeals.
Moral Issues in Business
Chapter 6

15. *
Deception and Unfairness in AdvertisingThe Federal Trade
Commission’s (FTC) role: Created in 1914 as an antitrust
weapon, it was expanded to include protecting consumers
against deceptive advertising and fraudulent practices.Is the
FTC (or other regulatory bodies) obligated to protect only
reasonable, intelligent consumers who act sensibly in the
marketplace?Or should it also protect ignorant consumers who
are careless or gullible in their purchases?
Moral Issues in Business
Chapter 6
*
Deception and Unfairness in AdvertisingThe Federal Trade
Commission’s (FTC) role: Should the FTC use the reasonable-
consumer standard or the ignorant-consumer standard? Adopting
the former would entail protecting only reasonable people from
deceptive advertising – if so, gullible consumers would be
unprotected.Adopting the latter would mean prohibiting
advertisements that can deceive anyone – if so, the FTC’s
restrictions and caseload would expand.It now follows a
modified ignorant-consumer rule.
Moral Issues in Business
Chapter 6

16. *
Deception and Unfairness in AdvertisingAdvertising to
children: Children are particularly susceptible to the
exaggerations of advertising.Advertisers say that parents still
control what gets purchased and what doesn’t. Critics doubt the
fairness of selling to parents by appealing to children.Childhood
obesity: The Institute of Medicine’s 2005 report, reviewing 123
research studies spanning 30 years, showed that exposure to TV
ads is “associated” with obesity in children under twelve.
Moral Issues in Business
Chapter 6
*
The Debate Over AdvertisingConsumer needs: Defenders of
advertising (such as Harvard business professor Theodore
Levitt) view its imaginative, symbolic, and artistic content as
answering real human needs.
Moral Issues in Business
Chapter 6
*

17. The Debate Over AdvertisingManipulation: Critics (such as
John Kenneth Galbraith) say that advertising manipulates those
needs or even creates artificial ones. He also suggests that: The
same process that produces products also produces the demand
for those products (the dependence effect).Advertising
encourages a preoccupation with material goods and leads us to
favor private consumption at the expense of important public
goods and services.
Moral Issues in Business
Chapter 6
*
The Debate Over AdvertisingMarket economics, free speech,
and the media: Defenders of advertising say that it has three
advantages: It is a necessary and desirable aspect of a free-
market systemIt is a protected form of free speechIt is a useful
sponsor of the media, especially televisionHowever, critics
challenge all three claims.
Moral Issues in Business
Chapter 6
*