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Ramsey Model Transparencies
Ramsey Model Transparencies
Sarantis Kalyvitis
Contents:
- Introduction
Advantages:
But: stronger analytical tools are needed, because the problem of consumers is
intertemporal!
1
The Household in the Ramsey model
Assumptions:
Budget constraint (the change in assets equals the sum of labor and interest
income less consumption):
•
B = wt Lt + rt Bt − Ct
Bt: assets
wt: wage rate and
rt: interest rate.
• Bt Ct
In per capita terms: b = wt + rt bt − nbt − ct where bt = , ct = .
Lt Lt
⇒ the present value of current and future assets must be asymptotically non-
negative
⇔ households cannot borrow infinitely until the end of their economic life cycle
⇔ the households’ debt cannot increase at a rate asymptotically higher than the
interest rate
t
− ∫ ( rs − n ) ds
lim bt e 0 ≥0
t →∞
2
Intertemporal utility:
∞ ∞
∫ ∫
− ρt
U = u (ct ) Lt e dt = u (ct ) e nt e − ρt dt
0 0
(2) satisfies the Inada conditions: lim u´(c) = ∞ and lim u´(c) = 0 .
c →0 c →∞
∂J
= 0 ⇒ v = u ′(c ) e − ( ρ − n ) t
∂c
∂J • •
= −ν ⇒ ν = − ( r − n )v
∂b
Transversality condition:
lim(ν t bt ) = 0
t →∞
The value of the representative household’s assets must approach zero as time
approaches infinity ⇔ individuals do not prefer to hold assets perpetually or –if
they do- these assets should have no value in terms of the objective function.
3
From the first-order conditions we get:
•
u′′(c) c c
Euler equation: r = ρ − .
u′(c) c
The higher r, the more willing households are to save and shift
consumption in the future.
The higher the rate of return to consumption is, the more willing
households are to sacrifice future consumption for more current
consumption and thereby less current saving.
Question: why do households prefer to bring some future consumption into the
present?
they value more current utility compared to the future one, as this is
reflected by the rate of time preference from the right-hand term of the Euler
equation.
•
c
the future consumption growth increases the marginal utility of
c
consumption.
4
Parametric form for utility function:
c 1−θ
constant relative risk aversion (CRRA) utility function: u (c) =
1−θ
u ′′(c)
Elasticity of marginal utility with respect to consumption is − c ′ and
u (c )
reflects the coefficient of relative risk aversion.
For the CRRA utility function, this elasticity equals θ (constant for all c)
For the CRRA utility function, the Euler equation takes the simple form:
•
c 1
= (r − ρ ) Euler equation for CRRA utility
c θ
1
Here gives ‘the elasticity of substitution between consumption at different
θ
time periods’ and reflects the individuals’ willingness to accept deviations from
a uniform pattern of consumption over time. The lower θ (i.e. the higher the
elasticity of substitution is), the slower the decline of the marginal utility in
response to consumption growth, and therefore the more willing are individuals
to accept variations in their consumption.
5
Firms’ behavior in the decentralized economy
Assumptions:
π i = F ( K i , Li ) − (r + δ ) K i − wLi
First-order conditions:
∂π i
=0 ⇒ f ′(k ) = r + δ
∂K i
∂π i
=0 ⇒ f (k ) − kf ′(k ) = w (marginal product of labor = wage rate)
∂Li
Ki K
where k = = since firms are identical.
Li L
6
Equilibrium in the Ramsey model
In equilibrium the stock of per capita assets equals the stock of capital per
worker, i.e. b=k:
•
⇒ k = f (k ) − (n + δ )k − c
•
c 1
= ( f ′(k ) − δ − ρ )
c θ
In the steady-state growth rates of per capita consumption and the capital stock
• •
per worker equal zero (i.e. k = c = 0 ) and we have:
c = f (k ) − (n + δ )k
f ′(k ) = δ + ρ
7
Dynamics in the Ramsey model
•
∂k
Dynamics of capital accumulation: = −1
∂c
c
•
k =0
•
∂c 1
Dynamics of consumption growth rate: = f ′′(k ) < 0
∂k θ
⇒ when the capital stock increases, the consumption growth rate is diminishing.
c
•
c=0
k k
8
Graphical solution of the system (phase diagram):
c
•
c=0
c*
c
•
k =0
k k
• •
Equilibrium: crossing point of the c = 0 and k = 0 schedules.
For any other point, the time paths of c and k are determined by the system of
equations.
9
Variations in the rate of time preference
c′
•
c k =0
k k′ k
•
For a given level of k, a decrease in ρ lowers the consumption growth rate c,
•
and hence, shifts the c = 0 schedule to the right.
•
⇒ to maintain consumption constant ( c = 0 ), the capital stock must increase so
that, in the new long-run equilibrium, consumption, capital and output per capita
attain a higher level ( k ′ > k , c ′ > c ).
Driving force of equilibrium: consumption jumps along the saddle path (here
consumption declines), whereas capital per worker remains at the same level k .
The reduction in consumption boosts saving and thereby leads to a increase in
capital stock, until it reaches k ′ . ⇒ income per capita level rises, with positive
consumption growth rate until reaching the higher levels of consumption and
capital ( c ′ , k ′ ), and income.
10
The modified ‘golden rule’ of capital accumulation
Result. In the Ramsey model, the long-run equilibrium level of capital per
worker is lower than the steady-state level predicted by the Solow-Swan
model.
In the Ramsey model households save less than the level prescribed by the
‘golden rule’ since in the Solow-Swan model there in no discounting of future
utility.
c
•
c=0
c*
c
•
k =0
k k* k
11
The ‘social planner’ problem
• •
Y = C + I ⇒ F ( K , L) = C + K + δK ⇒ k = f (k ) − (n + δ ) k − c
c 1−θ ( n − ρ ) t
J= e + ν [ f (k ) − (n + δ ) k − c ]
1−θ
∂J
= 0 ⇒ ν = c −θ e ( n − ρ )t
∂c
∂J • •
= −ν ⇒ ν = ν [n + δ − f ′(k )]
∂k
• •
Since c = k = 0 in the steady state, equations (6.23) and (6.28) become:
12
Τhe ΑΚ model with consumption optimization
•
k = ( A − δ − n) k − c
•
c 1
= (A − δ − ρ)
c θ
⇒ the growth rate is constant and independent from the level of the capital stock
per worker.
⇒ capital and income per capita increase at the growth rate of consumption.
Result. In the equilibrium of the linear growth model the following relation
holds:
• • •
k c y 1
= = = (A − δ − ρ)
k c y θ
Proof: see appendix.
the higher the constant Α (reflecting the state of technology), the faster the
long-run growth is.
the growth rate is negatively affected by the depreciation rate δ (the more
capital is used up, the slower the pace of development)
the growth rate is negatively affected by the discount rate ρ,
the growth rate is negatively affected by the elasticity of the marginal utility
with respect to consumption θ.