(Requires Some Calculus)In the Following,assume That Xt Is Strictly Exogenous

question 27

Essay

(Requires some calculus)In the following,assume that Xt is strictly exogenous and that economic theory suggests that,in equilibrium,the following relationship holds between Y* and Xt,where the "*" indicates equilibrium.
Y* = kXt
An error term could be added here by assuming that even in equilibrium,random variations from strict proportionality might occur.Next let there be adjustment costs when changing Y,e.g.costs associated with changes in employment for firms.As a result,an entity might be faced with two types of costs: being out of equilibrium and the adjustment cost.Assume that these costs can be modeled by the following quadratic loss function:
L = λ1(Yt - Y*)2 + λ1(Yt - Yt-1)2
a.Minimize the loss function w.r.t.the only variable that is under the entity's control,Yt and solve for Yt.
b.Note that the two weights on Y* and Yt-1 add up to one.To simplify notation,let the first weight be θ and the second weight (1-θ).Substitute the original expression for Y* into this equation.In terms of the ADL(p,q)terminology,what are the values for p and q in this model?

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Alexander Hamilton

A Founding Father of the United States, first Secretary of the Treasury, and key figure in the establishment of the national financial system.

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The 1803 Supreme Court case that established the principle of judicial review in the United States, allowing courts to strike down laws, statutes, and some government actions that violate the Constitution.

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John Marshall

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