Ramsey–Cass–Koopmans Model (1):

Setup of the Model and Competitive Equilibrium Path

Ryoji Ohdoi
Dept. of Industrial Engineering and Economics, Tokyo Tech

This lecture note is mainly based on Ch. 8 of Acemoglu (2009). Ch. 2 of Blanchard and
Fischer (1989) and the same chapter of Barro and Sala–i–Martin (2004) also provide excellent
explanations of the Ramsey–Cass–Koopmans model.

Contents

1 Setup of the Baseline Model 2

1.1 Households . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.2 Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

2 Competitive Equilibrium Path 5

2.1 Market Clearing Condition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2.2 Definition of Competitive Equilibrium Path . . . . . . . . . . . . . . . . . . . . 6

3 The Social Optimum and The First Theorem of Welfare Economics 7

4 Steady State 8

5 Transitional Dynamics 10
5.1 Diagrammatic Analysis of Global Dynamics . . . . . . . . . . . . . . . . . . . . 10
5.2 Local Dynamics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

6 Summary 14

1
1 Setup of the Baseline Model
• Recall that in the model of Solow (1956), consumption C and savings S are proportional
to current income Y :
S = sY, C = (1 − s)Y,

where s ∈ (0, 1) is the saving rate which is assumed to be exogenous.

• Ramsey-Cass-Koopmans model (or simply, Ramsey model): differs from the

Solow’s model in the respect that it endogenizes the saving rate by explicitly introducing
the consumer’s infinite-horizon optimization to the model.

1. How much should a nation save? Ramsey (1928) discussed such a problem of “op-
timal saving” by explicitly modeling the decision to save.
2. Cass (1965) and Koopmans (1965) used Ramsey (1928) to extend the neoclassical
growth model of Solow (1956), Swan (1956) and Phelps (1961).

→ Ramsey–Cass–Koopmans model now gives us a benchmark for many areas of modern

macroeconomic analysis.

1.1 Households

Demographics

• The economy consists of a set of identical households. Lt ≥ 0 denotes the size of popu-
lation at date t ≥ 0.

• Population Lt grows at a constant rate of n:

L̇t (≡ dLt /dt) = nLt , (1)

It is assumed that L0 = 1. Then Lt = exp(nt).

(∗) Hereafter, a dot over a variable is a time derivative of this variable.

Preferences

• The preferences of the representative household are represented by

∫ ∞
U0 = Lt × [e−ρt u(ct )]dt, (2)
0

where

– ct : per capita consumption (ct = Ct /Lt ); Ct is aggregate consumption

– ρ > 0: the subjective discount rate.
– u(c): the instantaneous utility function, assumed to satisfy

u′ (c) > 0, u′′ (c) < 0.

2
 • Using (1), the utility is rewritten as1
∫ ∞
U0 = e−(ρ−n)t u(ct )dt. (2’)
0

To ensure that there is discounting of future utility streams, we assume

 
Assumption 1. ρ > n.
 

Budget Constraint

• Each worker (household) is endowed with one unit of time, and inelastically supplies.
Therefore the population Lt corresponds to amount of labor.

• The budget constraint of all households:

Ȧt = rt At + wt Lt − Ct . (3)

where

– At : amount of total assets held by households

– rt and wt : the interest– and wage rate.

• Defining “per capita assets” as at ≡ At /Lt , (3) is rewritten as

ȧt = (rt − n)at + wt − ct . (4)

Intertemporal Utility Maximization

• The utility maximization problem of the representative household:

∫ ∞
max U0 = exp(−(ρ − n)t)u(ct )dt
0
s.t. ȧt = (rt − n)at + wt − ct (flow budget constraint),
a0 given (initial condition),
( ∫ t )
lim at exp − (rs − n)ds ≥ 0 (no-Ponzi-game condition),
t→∞ 0

1
Barro and Sala–i–Martin (2004) and Acemoglu (2009) assume (2) or (2’) as the objective function of the
representative household at date 0. Blanchard and Fischer (1989), on the other hand, assume that the sum of
the representative member’s instantaneous utility as her objective function:
∫ ∞ ∫ ∞
Lt × [e−ρt u(ct )]
U0 = dt = e−ρt u(ct )dt.
0 Lt 0

Although such a difference slightly changes the household’s first-order-conditions of utility maximization, key
features of competitive equilibrium obtained below remain intact whichever we assume.

3
 • Current-value Hamiltonian:

H(at , ct , µt ) = u(ct ) + µt [(rt − n)at + wt − ct ].

• Necessary and Sufficient conditions of utility maximization are

∂H/∂ct = 0 ⇔ u′ (ct ) = µt , (5)

∂H/∂at + µ̇t − (ρ − n)µt = 0 ⇔ µ̇t /µt = ρ − rt , (6)
lim µt at e−(ρ−n)t = 0. (7)
t→∞

From (5) and (6), we obtain the following Euler equation:

ct u′′ (ct ) ċt
− = rt − ρ. (8)
u′ (ct ) ct
∫t
On the other hand, from (6) we have µt = µ0 exp( 0 (ρ − rs )ds). Substituting this into
(7) yields ( ∫ t )
lim at exp − (rs − n)ds = 0. (9)
t→∞ 0

• In sum, the household’s utility-maximizing behavior is characterized by

1. Initial condition: the value of a0

2. Flow budget constraint (4)
3. Euler equation (8),
4. TVC (9)

1.2 Firms

Technologies
• Output, Yt , is produced using physical capital, Kt , and labor, Lt :

Yt = F (Kt , Lt ). (10)
 
Assumption 2. F is homogenous of degree one: F (vK, vL) = vF (K, L) for all v ≥ 0,
K ≥ 0 and L ≥ 0.
 

• There are many identical firms, each with the same constant-returns-to-scale technology
as described by (10).

• A representative firm’s profit maximization problem is

max F (Kt , Lt ) − Rt Kt − wt Lt , (11)

K,L

where Rt is the rental rate of capital: the relationship between this and the interest rate
is
Rt − δ = rt . (12)

4
 • Here we introduce a new variable indicating capital-labor ratio, k ≡ K/L. From the linear
homogeneity of the function F , we can define f as the per capita production function:

f (k) ≡ F (k, 1).

 
Assumption 3. f satisfies (i)f ′ (k) > 0, (ii) f ′′ (k) < 0, (iii) f (0) = 0, (iv) limk→0 f ′ (k) =
∞, and (v) limk→∞ f ′ (k) = 0.
 

Example: F (K, L) = AK α L1−α , where A > 0 and 0 < α < 1. In this case f (k) ≡ Ak α . It is
easily verified that the Cobb–Douglas production function satisfies Assumptions 2 and 3.

Profit Maximization under Perfect Competition

• Profit maximization problem (11) is now rewritten as

max (f (kt ) − Rt kt − wt ) Lt . (13)

k,L

• Under perfect competition, the firms takes Rt and wt as given. The first-order conditions
are

kt : Rt = f ′ (kt ), (14)
Lt : wt = f (kt ) − kt f ′ (kt ). (15)

• It is quite easy to find that from (14) and (15),

Rt kt + wt = f (kt ). (16)

2 Competitive Equilibrium Path

2.1 Market Clearing Condition

• Labor market equilibrium:

→ We have already imposed this condition.
(∵) Both supply of labor (in (3)) and demand of labor (in (11)) are denoted by Lt .

• Asset market equilibrium:

→ In practice, household assets, At can consists of

1. (claims to) Capital stock, Kt , which the households rent to firms,

2. Individual bonds (IOUs) due to lending and borrowing within households
→ these bonds are in zero net supply.

5
 Therefore, the asset market equilibrium is given by

At = Kt ⇔ at = kt . (17)

↓
(∗) Implication of (12):

interest rate (rt ) = rate of return on capital (Rt ) − capital depreciation rate (δ)

• Goods market equilibrium:

→ Goods market equilibrium is given by

F (Kt , Lt ) = Ct + K̇t + δKt .

| {z } |{z} | {z }
Gross Domestic Product Consumption Aggregate Investment

In per capita terms,

k̇t = f (kt ) − (n + δ)kt − ct . (18)
 
Caution:

1. Substituting (17) into the household’s per capital budget (4):

k̇t = (rt − n)kt + wt − ct

2. Substituting (12) into the result:

k̇t = (Rt − n − δ)kt + wt − ct

3. Finally substituting (16) into the above equation:

k̇t = f (kt ) − (n + δ)kt − ct .

Thus, the goods market equilibrium is endogenously obtained from the other con-
ditions of market equilibria and the economic agents’ (i.e., household’s and firm’s)
budget constraint. → Walras’ law.
 

2.2 Definition of Competitive Equilibrium Path

• As already known, the household’s budget constraint (4) is combined with (12), (16) and
(17) to give (18):

k̇t = f (kt ) − (n + δ)kt − ct . (18)

This equation describes the dynamics of physical capital kt , which depends on kt and ct .

6
 • On the other hand, from (12) and (14),

(12) : rt = Rt − δ
= f ′ (kt ) − δ. ∵ (14).

Substituting this equation into the household’s Euler equation (8), we can obtain

ct u′′ (ct )
− = f ′ (kt ) − δ − ρ. (19)
u′ (ct )

This equation describes the dynamics of consumption ct , which depends on kt and ct .

• Furthermore, Imposing at = kt in (9) and substituting rs = f ′ (ks ) − δ into the reuslt, we

can express the TVC as follows:
( ∫ t )
lim kt exp − (f ′ (ks ) − n − δ)ds = 0. (20)
t→∞ 0

• The initial condition is given by k0 (= a0 ).

Now we are in position to define the Competitive Equilibrium Path.

Definition 1 (Competitive Equilibrium Path). Given k0 > 0, the paths of kt and ct which
jointly satisfy (18)–(20) constitute a competitive equilibrium path.

3 The Social Optimum and The First Theorem of Welfare Economics

Before going to further characterization of competitive equilibrium, let us turn to the social
planner’s optimal growth problem.

• Briefly, the social planner is the agent who

– maximizes the representative household’s life-time utility (2),

– directly faces the dynamics of kt , (18), as the constraint of the problem.

→ Any allocation chosen by a social planner is called the socially optimal allocation or
command optimum. By definition, this is the first-best.

• The social planner’s problem is given by

∫ ∞
max U0 = e−(ρ−n)t u(ct )dt,
0
s.t. k̇t = f (kt ) − (n + δ)kt − ct ,
k0 ≥ 0 given.

7
 • The current–value Hamiltonian associated with the above problem is given by

Ĥ(kt , ct , ηt ) = u(ct ) + ηt (f (kt ) − (n + δ)kt − ct ) .

Then, the optimal path is characterized by (18) and

∂H
= 0 ⇔ u′ (ct ) = ηt , (21)
∂c
∂H
+ η̇t − (ρ − n)ηt = 0 ⇔ η̇t = (ρ + δ − f ′ (kt ))ηt , (22)
∂k
lim ηt kt e−(ρ−n)t = 0. (23)
t→∞

From (21) and (22), we can obtain the same equation

[∫ as the dynamics
] of ct , (19). On
t ′
the other hand, from (22) we have ηt = η0 exp 0 (ρ + δ − f (ks ))ds . Substituting this
into (23) gives the same condition as (20).

Proposition 1. The competitive equilibrium path achieves the first-best allocation.

• Both of (18) and (19) are nonlinear differential equations.

→ How can we derive the competitive equilibrium path?

1. Examine the existence and uniqueness of steady state:

A steady state is defined as an equilibrium path in which kt and ct are constant.
2. Examine the stability of the steady state:
Briefly speaking, the stability of steady state refers to the ability of the steady state
to converge to it when the initial value of the state variable k0 is different from the
steady state.
3. Check whether or not the path is uniquely determined or not.

4 Steady State
• A steady state is defined as an equilibrium path in which kt and ct are constant. We
denote the steady state values of these variables, k ∗ and c∗ , respectively.

• From (19) with ċt = 0, we have

f ′ (k ∗ ) = ρ + δ. (24)

Note that from property (iv) and (v) of Assumption 3, there uniquely exists k ∗ > 0 that
solves the above equation.

• Once k ∗ is uniquely determined, the dynamics of kt , (18) with k̇t determines the steady
state consumption level:
c∗ = f (k ∗ ) − (n + δ)k ∗ . (25)

8
Proposition 2. There exists a unique steady state (k ∗ , c∗ ) that satisfies the TVC (20) and
k ∗ > 0 and c∗ > 0.

Proof. Since k ∗ > 0 has been already shown, it is sufficient to show that c∗ > 0 and that k ∗
satisfies the TVC. Recall that f (k) is strictly concave and f (0) = 0 are assumed in Assumption
3. Then, it follows that

f (k ∗ ) > f (0) + f ′ (k ∗ )(k ∗ − 0) ∀k > 0 → f (k ∗ ) > f ′ (k ∗ )k ∗ ∀k ∗ > 0

Substituting this result into (25) and using (24), we obtain

c∗ > f ′ (k ∗ )k ∗ − (n + δ)k ∗ = [f ′ (k ∗ ) − (n + δ)]k ∗

= [ρ + δ − (n + δ)]k ∗
= (ρ − n)k ∗ .

Since ρ − n > 0 holds from Assumption 1, we can show that c∗ > 0.

Next we will show that k ∗ satisfies the TVC. Substituting k ∗ into the left-hand-side (LHS)
of (20) and using (24),
[ ]
LHS of (20) = lim k ∗ exp −(f ′ (k ∗ ) − n − δ)t
t→∞

= lim k ∗ exp [−(ρ + δ − n − δ)t]

t→∞

= lim k ∗ exp [−(ρ − n)t]

t→∞

Since ρ − n > 0 holds from Assumption 1 and k ∗ is finite, we can show the LHS converges to
zero.

• Figure 1 graphically show how k ∗ and c∗ are determined.

• In Figure 1, kg is defined as

kg = arg max f (k) − (n + δ)k.

k

That is, kg is called the Golden Rule of Capital Stock.

Lemma 1. k ∗ < kg under Assumption 1.

Proof. Exercise.

9
 O

Figure 1: Steady State

5 Transitional Dynamics
• (18) and (19) are the system of differential equations of kt and ct .
These equations are called the autonomous dynamic system of the model.2

• Since k0 is historically given, the equilibrium paths of kt and ct are determined, once c0
is determined.

• Then, how can we solve the equations for c0 ?

1. Graphical Solution: we depict the phase diagram.

2. Analytical Solution: we linearize the system of equations (18) and (19) in the neigh-
borhood of the steady state, and then solve these approximated equations.
3. Numerical Solution

5.1 Diagrammatic Analysis of Global Dynamics

• From (18) and (19),

k̇t ⋛ 0 ⇔ ct ⋚ f (kt ) − (n + δ)kt , (26)

u′ (ct ) ′
ċt ⋛ 0 ⇔ − ′′ (f (kt ) − δ − ρ) ⋛ 0. (27)
u (ct )

2
Consider the system of differential equations of variables xt and yt . Then the system is called autonomous
when it depends on time only through the variables xt and yt .

10
 
u′ (c)
Assumption 4. − = 0 if c = 0.
u′′ (c)
 

Example: If we specify u as the CRRA form:

c1−θ − 1
u(c) = for θ > 0, θ ̸= 1,
1−θ
then −u′ (c)/u′′ (c) = c/θ. So this function satisfies this assumption.

• Therefore, (27) is simplified to

ċt ⋛ 0 ⇔ f ′ (kt ) ⋛ ρ + δ
⇔ kt ⋚ k ∗ when ct > 0, (28)

and ċt = 0 for all kt when ct = 0.

unstable arm
stable arm

B E

A’
A
A” D
O

Figure 2: Phase Diagram

• Figure 2 depicts the dynamics of kt and ct given by (26) and (28).

• Note that all points in the positive orthant are feasible. So there is a continuum of feasible
paths. However, the paths are classified mainly into the following three types.

1. The path that converges to the steady state (k ∗ , c∗ ). Given k0 , a representative

shape of this type is depicted by the curve AE.

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 2. The paths that eventually hit the vertical axis, and move to the origin. Given k0 , a
representative shape of this type is depicted by the curve A′ B. Once the path hits
the point B, then it jumps to the point O.
3. The paths that converge to the steady state (k, 0), where k is the steady state capital
stock with zero consumption: f (k) = (n + δ)k. Given k0 , a representative shape of
this type is depicted by the curve A′′ D.

Proposition 3. Only the path converging to the steady state (k ∗ , c∗ ) is optimal.

Proof. We show that on all other paths, either the Euler equaiton (19) eventually falls or the
TVC (20) is not satisfied.
At first, consider the paths which eventually hit the vertical axis. Note that on this type
of paths, ċt > 0 and the sign of k̇t becomes negative sooner or later. Differentiating (18) yields
 dk̇ 
 t
  = −[f ′ (kt ) − (n + δ)]k̇t + ċt > 0.
dt
This implies that these paths hit the vertical axis in finite time. When a path reaches the
vertical axis, kt becomes zero. Then the economy has to jump to the origin. However, such
a jump violates the Keynes-Ramsey rule, which imposes ct to continuously move over time.
Therefore, all the paths hitting the the vertical axis cannot be optimal.
Second, consider the paths converging to the steady state (k, 0). Note that in this steady
state it follows that
f ′ (k) < n + δ = f ′ (kg ).

The above inequality shows

lim k exp[(n + δ − f ′ (k))t] = ∞.

t→∞

Thus, the steady state (k, 0) does not satisfy the TVC.

5.2 Local Dynamics

Linearization of the Dynamic System (18) and (19)

• Linearization of the dynamic system yields further insights into the dynamic behavior.

• A first-order Taylor expansion of (18) and (19) around the steady state (k ∗ , c∗ ) gives

k̇t ≃ (ρ − n)(kt − k ∗ ) − (ct − c∗ ),

and
f ′′ (k ∗ )u′ (c∗ )
ċt ≃ − (kt − k ∗ ).
u′′ (c∗ )

12
 Then, the local dynamics is given by
( ) ( )( )
k̇t ρ−n −1 kt − k ∗
= .
ċt −f ′′ u′ /u′′ 0 ct − c∗

Let J denote the Jacobian matrix of the dynamics:

( )
ρ−n −1
J≡ .
−f ′′ u′ /u′′ 0

• So the eigenvalues of J are given by the values of ω that solve the following quadratic
equation:
det(J − ωI) = 0 ⇔ ω 2 − (ρ − n)ω − f ′′ u′ /u′′ = 0

The above equation is called the characteristic equation.

• Generally, in the two variable–two equation dynamic system, steady state is called

1. Saddle point, if the system has one positive- and one negative eigenvalues,
2. Source, if the system has two positive eigenvalues,
3. Sink, if the system has two negative eigenvalues.

• Since −f ′′ u′ /u′′ < 0 represents the product of the two roots and the sign of this is
negative, there are two real eigenvalues, one negative and one positive.

Lemma 2. The steady state (k ∗ , c∗ ) is a saddle point.

• Without any loss of generality, let ω1 > 0 and ω2 < 0 respectively denote the positive
and the negative eigenvalues.

• Therefore, the general solution is given by

( ) ( ) ( )
kt − k ∗ v11 v12
= Z1 exp(ω1 t) + Z2 exp(ω2 t), (29)
ct − c∗ v21 v22

where

– vj ≡ (v1j , v2j )T : the eigenvector corresponding to the eigenvalue ωj ,

– Zj : a constant value still to be determined.

Determination of Initial Consumption

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 • Now we will show that when the steady state is a saddle point, the initial consumption
is uniquely determined.
→ Accordingly, the competitive equilibrium path is uniquely determined.

• Since ω1 > 0, the economy never converges to the steady state (k ∗ , c∗ ) if Z1 would not
be zero.

• Since (29) holds at t = 0, we have

k0 − k ∗ = Z1 v11 + Z2 v12 , c0 − c∗ = Z1 v21 + Z2 v22 . (30)

• Thus, the initial consumption, c0 , is determined such that

1. Z1 = 0: otherwise the economy diverges from the steady state, and such a path
violates either the Keynes-Ramsey rule or the TVC;
2. Z2 = (k0 − k ∗ )/v12 : otherwise (30) does not hold given k0 .

In sum,

v22
Lemma 3. The initial consumption is determined as c0 = c∗ + (k0 − k ∗ ).
v11

• Therefore, from (29), we can analytically obtain the optimal growth path as follows:
kt − k ∗ = (k0 − k ∗ ) exp(ω2 t), ct − c∗ = (v22 /v12 )(k0 − k ∗ ) exp(ω2 t). (31)

(31) is the competitive equilibrium path near around the steady state.

Proposition 4. There exists a unique competitive equilibrium path.

6 Summary
• The Ramsey–Cass–Koopmans model is based on the economic agents’ intertemporal op-
timization.

• The competitive equilibrium path in this model corresponds to the social planner’s opti-
mal path which achieves the first-best allocation.

• There exists a unique steady state where both of physical capital and consumption are
positive.

• Saddle point stability of the steady state means the uniqueness of competitive equilibrium
path in this model.

14
References
[1] Acemoglu, D. (2009) Introduction to Modern Economic Growth, Princeton University
Press.

[2] Barro, R. J. and X. Sala-i-Martin (2004) Economic Growth, Second Edition, Cambridge,
MIT Press.

[3] Blanchard, O. and S. Fischer (1989) Lectures on Macroeconomics, Cambridge, MIT Press.

[4] Cass, D. (1965) “Optimum Growth in an Aggregate Model of Capital Accumulation,”

Review of Economic Studies 32, pp. 233–240.

[5] Koopmans, T. J. (1965) “On the Concept of Optimal Economic Growth, ” in The Econo-
metric Approach to Development Planning. Amsterdam: North Holland, pp. 225–295.

[6] Phelps, E. S. (1966) Golden Rules of Economic Growth, New York, W. W. Norton.

[7] Ramsey, F. (1928) “A Mathematical Theory of Saving,” Economic Journal 38, pp. 543–
559.

[8] Solow, R. M. (1956) “ A Contribution to the Theory of Economic Growth,” Quarterly

Journal of Economics 70, pp. 65–94.

[9] Swan, T. W. (1956) “Economic Growth and Capital Accumulation,” Economic Record 32,
pp. 334–361.

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