(a) Using equation 5.20 or 5.21, deduce the effect of (i) a decrease in a and (ii) an increase in r (ceteris paribus) on:

(a) M*

(b) A*

(c) m*

Note that you could answer this question analytically. Alternatively, you could explore the issue numerically using the Excel file Stock1.xls (found in the Additional Materials for Chapter 5).

(b) A reader of the third edition of this text posed the following queries: ‘I cannot understand, why in the case of alpha = 1, where there is no intertemporal problem, the optimality condition differs from the flow case? Also I do not understand, why in the case that there is no discounting the intertemporal solution equals the flow solution?’ Provide the necessary intuition to answer these queries.