Essay4307 - The Diamond Model How does this Overlapping...

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Unformatted text preview: The Diamond Model How does this Overlapping Generations Model explain the basic questions about growth? Dennis Paschke Course: Topics in Economic Theory 2 (EC4307) Lecturer/Tutor: Dr Laurence Lasselle Contents 2 Contents 1 Introduction_____________________________________________________________3 2 The Diamond Model______________________________________________________3 3 Growth in the Diamond Model______________________________________________4 4 Deficiencies of the Diamond Model__________________________________________8 5 Conclusions_____________________________________________________________9 Notes _____________________________________________________________________9 References ________________________________________________________________10 Introduction 3 1 Introduction This essay serves to develop the Diamond Model which was first developed by Peter A. Diamond (1965). However, the emphasis is not placed on the development of the model itself which can be found in many advanced textbooks 1 but on a careful presentation of the model to be able to understand how this model explains the basic questions of economic growth. These are: (1) Where does economic growth comes from? (2) Why have some countries higher growth rates than others? (3) Why are some countries richer than others? Section 2 presents the diamond model as far as it is useful for later discussions. Section 3 argues how the diamond model answers the basic questions (1)-(3) about economic growth. Section 4 discusses benefits and deficiencies of the model in explaining economic growth. Section 5 is to summarise and to conclude. 2 The Diamond Model The Diamond Model is a so-called Overlapping Generations Model (OLG). In every period t with ,... 2 , 1 , = t , i.e. time is discrete, there are always two types of households, young and old who are continually born or are continually dying, respectively. Moreover, every household is assumed to live for only two periods. The population is assumed to grow at rate n, i.e. inhabitants born in period t and period t-1, respectively, L t and L t- 1 , respectively, are determined by 1 ) 1 ( − + = t t L n L and ) 1 /( 1 n L L t t + = − , respectively. Each young inhabitant supplies one unit of labour and distributes the resulting income to first-period consumption and savings, respectively. Each old inhabitant only consumes first-period savings including interest. Every household maximizes utility by means of a constant- relative-risk-aversion utility function Growth in the Diamond Model 4 1 ; with 1 1 1 1 ) , ( 1 1 2 1 1 1 2 1 − > > − + + − = − + − + ρ θ θ ρ θ θ θ t t t t t C C C C u . Where C 1t and C 2t+1 is the consumption of a household born in period t when it is young and old, respectively....
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Essay4307 - The Diamond Model How does this Overlapping...

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