Solution - York University

(d) When capital exhibits diminishing MPK the resource constraint in per young personterms is:c 1 + c 2n+ k ≤ y +f(k) + (1 − δ)knThe optimal level of the capital stock, ̂k, must satisfy again MB = MC. In thiscase the condition boils down to: f ′ (k)+(1−δ)n(e) The rate of return to money is:v t+1v t= n z= 1. See Fig.5.interest rate, r t . If all three assets are held that means that:. The rate of return to IOUs is the realv t+1v t= r t = f ′ (k)+(1−δ)n. Then an increase in z causes a decrease inor equivalently that, n zthe return to money and thus a decrease in the MP K, inducing an increase in the= f ′ (k)+(1−δ)ncapital stock. This is the Tobin Effect. The nominal interest rate is: R t = r t ( p t+1p t).A rise in z increases p t+1p t= z . This will cause an increase in R n t but this will not beone for one because at the same time we showed that r t falls (since the MPK falls).6