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Unformatted text preview: Economics 202A Lecture #2 Outline (version 1.4) Maurice Obstfeld I have commented on the ad hoc nature of the saving behavior postulated by Solow. The next model assumes instead that people plan ahead in making saving decisions. One advantage of this assumption is that we can do welfare analysis of economic changes. The model delivers &normative answers to questions such as, &How much should a country save?In its various forms, the following model has many applications in macroeconomics and public nance beyond the analysis of growth. The RamseyCassKoopmans Model in Discrete Time I will initially develop this model in discrete time. Then I will go to the continuoustime limit to derive a mathematical framework comparable to the Solow models. This will also serve to illustrate the principles of optimal control theory , a very useful tool. There are many other approaches to the derivation, such as the one based on dynamic programming in my notes at http://www.econ.berkeley.edu/~obstfeld/ftp/perplexed/cts4a.pdf. Another possible source is Martin Weitzmans book Income, Wealth, and the Maxi mum Principle (Harvard University Press, 2003). Assumptions: & There is a single composite good produced with the constantreturns production function for total output, Y = F ( K; N ) : Here, N is popu lation, which I assume equal to the (fully employed) labor force. (Feel free to add laboraugmenting technical change as an exercise.) & Population growth is N t = (1 + n ) N t & 1 . & A &generationlives for a period t and maximizes U t = u ( c t ) + & (1 + n ) U t +1 , where & (1 + n ) < 1 and c t is the consumption of a representative family member on date t . The idea is that you care about your own consumption and the welfare of your 1 + n children. 1 & Capital depreciates at the rate & 2 [0 ; 1] . Because U t = u ( c t )+ (1+ n ) u ( c t +1 )+ 2 (1+ n ) 2 u ( c t +2 )+ 3 (1+ n ) 3 U t +3 , etc., we may assert that the generation born on date t = 0 maximizes U = 1 X t =0 t (1 + n ) t u ( c t ) subject to K t +1 K t = F ( K t ; N t ) N t c t &K t ; K t ; K given. Alternatively, we can express the constraints in the intensive form k t +1 = 1 1 + n [ f ( k t ) + (1 & ) k t c t ] ; k t ; k given, where k K=N; f ( k ) = F ( k; 1) : Ramsey looked at the case n = 0 and = 1 . The latter assumption may seem paradoxical from a mathematical point of view (isn&t the innite sum dening U likely to be divergent then?), but a problem set will show how Ramsey handled it. One simplication is to assume the Inada condition on consumption that lim c ! u ( c ) = 1 . In that case, we can forget about the interim nonnegativity constraints on the capital stock. We will never optimally get close to zero capital, because the marginal utility of consumption would be very high....
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This note was uploaded on 11/27/2011 for the course ECON 101 taught by Professor Robert during the Fall '08 term at Montgomery College.
 Fall '08
 Robert
 Economics

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