Luke SteinStanford graduate economics core (2006–7)Econ 210–211 reference and review (last updated April 11, 2012)
1 Models
Two period intertemporal choice model
(Nir 1-11)
Maximize
U
(
C
0
,C
1
) subject to
C
0
+
S
0
≤
Y
0
and
C
1
≤
RS
0
. Theconstraints can be rewritten
C
0
+
1
R
C
1
≤
Y
0
.
Neoclassical growth model (discrete time)
(Nir 3-3–5, 11-3,8, 10, 16–28, 12-12–26)
(a.k.a. Ramsey model) Maximize
t
β
t
U
(
c
t
) subject to:1.
c
t
+
k
t
+1
≤
F
(
k
t
,n
t
) + (1
−
δ
)
k
t
for all
t
(RHS can bedenoted
f
(
k
t
,n
), or
f
(
k
t
), since the lack of disutility of working ensures that
n
t
= 1);2.
k
t
+1
≥
0 for all
t
;3.
c
t
≥
0 for all
t
;4.
k
0
is given.We further assume
U
(
·
) satisﬁes Inada conditions; that theproduction function is constant returns to scale and satis-ﬁes
F
k
>
0,
F
kk
<
0,
F
n
>
0, and
F
nn
<
0; and TVClim
t
→∞
β
t
U
(
c
t
)
f
(
k
t
)
k
t
= 0.The problem can be rewritten in “SL canonical form”as maximizing
t
β
t
U
(
f
(
k
t
)
−
k
t
+1
) subject to
k
t
+1
∈
[0
,f
(
k
t
)], the given
k
0
, and conditions on
f
(
·
) and
U
(
·
)as above. In functional equation form, we write
V
(
k
)
≡
max
k
∈
[0
,f
(
k
)]
U
(
f
(
k
)
−
k
)+
βV
(
k
) (again, with additionalconditions as above).Steady state satisﬁes
βf
(
k
∗
) = 1. Note the utility func-tion does
not
aﬀect the steady state (although it will aﬀectdynamics).Linearization of the intereuler
u
(
f
(
k
t
)
−
k
t
+1
)
−
βf
(
k
t
+1
)
u
(
f
(
k
t
+1
)
−
k
t
+2
) = 0about steady state gives:
k
t
+2
−
k
∗
k
t
+1
−
k
∗
≈
1 +
1
β
+
β
U
(
c
∗
)
U
(
c
∗
)
f
(
k
∗
)
−
1
β
1 0
k
t
+1
−
k
∗
k
t
−
k
∗
The optimal policy function
g
(
k
) satisﬁes:1.
g
(
·
) is single-valued, since the value function is strictlyconcave.2.
g
(0) = 0 since that is the only feasible choice.3.
g
(
k
) is in the interior of
γ
(
k
), since otherwise exactlyone of
U
(
c
) and
U
(
c
) would be inﬁnite, violating theIntereuler condition.4.
g
(
k
)
>
0, since as
k
increases, marginal cost of savinggoes down, while marginal beneﬁt stays same.5. There is unique
k
∗
>
0 such that
g
(
k
∗
) =
k
∗
.6.
k > k
∗
=
⇒
k > g
(
k
)
> k
∗
, and
k < k
∗
=
⇒
k <g
(
k
)
< k
∗
; i.e., capital moves closer to (without crossingover) the steady-state level.7. The sequence
k
0
,g
(
k
0
)
,g
(
g
(
k
0
))
,...
displays mono-tonic and global convergence.
Endowment economy, Arrow-Debreu
(Nir 13-4–6)
At everyperiod household gets
y
t
units of good; there is no storage,and trading in all commodities (goods delivered in each pe-riod) takes place in period 0. Maximize
β
t
U
(
c
t
) subjectto
p
t
c
t
≤
p
t
y
t
(budget constraint), and ensure
y
t
=
c
t
(market clearing).
Endowment economy, sequential markets
(Nir 13-7–9)
At ev-ery period household gets
y
t
units of good; there is no stor-age, and trading in “assets” (loans across periods) takes placeeach period. Maximize
β
t
U
(
c
t
) subject to
c
t
+
a
t
+1
≤
y
t
+
R
t
a
t
(budget constraint), and ensure
y
t
=
c
t
,
a
t
+1
= 0(market clearing).
Production economy, Arrow-Debreu
(Nir 13-10–6)
Householdowns capital rented for production by competitive ﬁrms,which also rent labor from households. Capital depreciates atrate
δ
. There is no storage, and trading in all commodities(goods delivered, capital rental, and labor in each period)takes place in period 0.1. Households maximize
β
t
U
(
c
t
) subject to
p
t
[
c
t
+
k
t
+1
]
≤
p
t
[
r
t
k
t
+ (1
−
δ
)
k
t
+
n
t
w
t
].2. Firms maximize (in each period)
p
t
F
(
k
t
,n
t
)
−
p
t
r
t
k
t
−
p
t
w
t
n
t
.3. Markets clear:
c
t
+
k
t
+1
=
F
(
k
t
,n
t
) + (1
−
δ
)
k
t
.Note the rental rate of capital (
r
t
) and wage rate (
w
t
) aremeasured in units of consumption good.
Production economy, sequential markets
(Nir 13-25)
Asabove, household owns capital rented for production bycompetitive ﬁrms, which also rent labor from households.Capital depreciates at rate
δ
. There is no storage, and eachperiod, goods delivered, capital rental, and labor are traded.Note there is no inter-period trading, so we do not need aprice for goods.1. Households maximize
β
t
U
(
c
t
) subject to
c
t
+
k
t
+1
≤
r
t
k
t
+ (1
−
δ
)
k
t
+
n
t
w
t
.2. Firms maximize (in each period)
F
(
k
t
,n
t
)
−
r
t
k
t
−
w
t
n
t
.3. Markets clear:
c
t
+
k
t
+1
=
F
(
k
t
,n
t
) + (1
−
δ
)
k
t
.Formulated recursively (assuming
n
= 1),1. Households have
V
(
k,K
) = max
c,k
[
U
(
c
) +
βV
(
k
,K
)subject to
c
+
k
=
R
(
K
)
k
+
W
(
K
); where
K
is aggre-gate capital, and
R
(
K
) and
W
(
K
) are the rental andwage rates as functions of aggregate capital. We furtherrequire the “forecast” of future capital to be rational:
K
=
G
(
K
), where
G
(
·
) is the optimal aggregate policyfunction.2. Firms maximize
F
(
K
)
−
RK
−
W
, which gives FOC
R
(
K
) =
F
k
(
K
) + 1
−
δ
and
W
(
K
) =
F
n
(
K
).3. Markets clear:
C
+
K
=
F
(
K
) + (1
−
δ
)
K
.4. Consistency:
G
(
K
) =
g
(
K,K
).
Overlapping generations
(Nir 17-15–6, 17-32)
In an endowmentOLG economy, a competitive equilibrium is Pareto optimaliﬀ
∞
t
=0
1
/p
t
=
∞
where the interest rate is
R
t
=
p
t
/p
t
+1
.In an an OLG economy with production, a competitive equi-librium is dynamic eﬃcient iﬀ
F
K
(
K
∗
) + 1
−
δ
≥
1.
Real Business Cycles model
(Nir 18-7–14)
Benchmark RBCmodel is NCGM with endogenous hours, ownership of ﬁrmsand capital by households, and stochastic productivity
A
t
multiplying labor (so production function is
F
(
k
t
,A
t
n
t
)).We speciﬁed:1. CRRA utility:
U
(
c,n
) =
c
1
−
σ
−
11
−
σ
−
n
1+
χ
1+
χ
;2. Cobb-Douglas production:
y
t
=
A
t
k
αt
n
1
−
αt
;3. Productivity given by log
A
t
=
ρ
log
A
t
−
1
+
ε
t
with
ε
t
distributed iid normal.
Optimal taxation—primal approach
(Nir 10)
Solve HH prob-lem and combine FOC and budget constraint with govern-ment budget constraint to get one expression that ties to-gether allocations but has
no prices or taxes
. Then gover-ment maximizes HH utility over
allocations
subject to thisconstraint.Note that in the case with capital,
∗
the problem is not sta-tionary; i.e., we cannot use our typical dynamic program-ming tools, and need to worry about the government’s abilityto commit to a future tax policy.
∗
We generally need to impose restrictions on ﬁrst-period taxation, since otherwise the government will tax capital very highly then (since it’s supplied perfectly inelastically).
1