You are on page 1of 2

Macroeconomics I: Economic Growth

Problem Set 2: The Ramsey model


September 23, 2004; due on September 28, 2004.
The decentralized competitive equilibrium in the Ramsey economy: The representative household has a strictly concave instantaneous utility function u(c t ) satisfying the Inada conditions, where c t = Ct /Nt is per-capita consumption. The size of the household grows at the exogenous rate n. The households objective functional is

U=
0

u(c t )e(n)t dt.

(1)

Assume that > n. There are two assets, capital Kt and loans At . In equilibrium they must command the same net return. Technology is given by the aggregate constant returns to scale production function F (Xt Nt , Kt ) = Xt Nt f (kt ), (2) t /Xt = , k Kt /(Xt Nt ), where Xt denotes the state of technology and evolves according to X and f (kt ) F (1, kt ). 1. Derive the ow budget constraint for the household, dening assets per capita as a t = At /Nt . (Note that households do not invest directly in capital, but only in assets. The latter are a claim on capital goods.) Denote wages by wt and the interest rate received by the household on its asset holdings by rt . Discuss the No-Ponzi-Game condition
t

lim a t e(

t 0 rs dsnt

) 0.

(3)

Write down the current-value Hamiltonian and derive the Euler equation of optimal consumer behavior. 2. Firms rent capital goods on a competitive rental market at rate Rt . That is, they do not themselves accumulate capital, thus their optimizing behavior is essentially static. Write down the prot function and the rst order conditions involving rt and wt . 3. General equilibrium: impose asset market clearing a t = kt Xt . Then use your results in question 2 to nd rst order dierential equations describing the dynamic behavior of ct and kt . 4. Why can the equilibrium of the above economy be modelled as a social planner problem? Write down the social planner problem and compare the resulting system of rst order dierential equations with your ndings in question 3. 1

5. Assume that technology is Cobb-Douglas


f (kt ) = kt ,

and the instantaneous utility function exhibits constant intertemporal elasticity of substitution c 1 1 u(c t ) = t . 1 Show analytically that the equilibrium of the economy exhibits the property of saddle (k, c) around the steady state path stability: rst, linearize your equations c (k, c) and k (kSS , cSS ). Then check in the matrix of coecients (the Jacobian) whether the characteristic roots (eigenvalues) are real and of opposite sign. Why is the saddle path the only optimal trajectory leading to the steady state? (Consider if other paths could be optimal.) 6. How do changes in aect the saddle path and the transition to the steady state? 7. Show that the steady-state savings rate is sSS = +n+ . + +

Analyze the dynamics of st along the transition path. Note that it is best to study the magnitude zt ct /f (kt ), i.e. the consumption rate. Show that gz z t 1 = kt zt 1 + zt + ( + + ) sSS 1 .

What is the implication of sSS > < 1/ for zt ? Compute gz and discuss the dynamic behavior of the savings rate. 8. Assume that the economy is on its balanced growth path (BGP). Study the eects of an unexpected and permanent increase in at t = T . Give a graphical illustration and discuss the properties of the new BGP and how the economy converges to it.

You might also like