The Lucas-Uzawa Models Closed-Form Solutions: Skemsys

1
The Lucas-Uzawa Models:

Closed-Form Solutions
(--Preliminary Version--)
9th of May 2011
Solomon M. Antoniou
SKEMSYS
Scientific Knowledge Engineering
and Management Systems
37 oliatsou Street, Corinthos 20100, Greece
solomon@otenet.gr
solomon_antoniou@yahoo.com
Abstract
We present explicit solutions in a number of Lucas-Uzawa Models. The models
are solved without dimensional reduction, using two different methods. The first
method uses a procedure similar to the dimensional reduction. However in our
method we do not consider solutions along the balanced growth path. The second
method has recently appeared in the literature. However, in our own calculations
the intermediate steps appear explicitly in an easy to follow algorithm. Some of
the results we derive exhibit differences compared to the results already found.
The solution procedure of models with externalities uses quite different techniques
to those known so far. The closed-form solutions of the models with externalities
appear for the first time in the literature.
Keywords: Economic Dynamics, Lucas-Uzawa model, Closed-Form Solutions,
Special Functions, Hypergeometric Functions.
-------------------------------------
The paper is available from: www.docstoc.com/profile/solomonantoniou
2

1. Introduction
Modern Economic Growth Theory has received considerable attention after its
formulation by Romer [26] and [27], and Lucas [17]. A central role is played by
the Uzawa-Lucas Model (Uzawa [33] and Lucas [17]). The reader may consult
any of the well-known text books on the subject, like Acemoglu [2], Aghion and
Howitt [3], Barro and Sala-i-Martin [5], Greiner, Semmler and Gong [13] and
Romer [28]. We should also mention Greiner and Semmler [12], Uzawa [34] and
Xepapadeas [36] who consider a number of environmental issues examined within
the Lucas-Uzawa models.
There is a number of papers which claim either they have found closed-form
solutions or they have simplified considerably the equations of motion, like
Benhabib and Perli [6], Bethmann [7], Bucekkine and Ruiz-Tamarit [8], Caball
and Santos [9], Hiraguchi [14], Mattana [19] and [20], Moro [21] and Mulligan
and Sala-i-Martin [23] among others. Most of the solution methods first use
dimensional reduction and then the model is solved along the balanced growth
path (usually known as BGP). The only exception is the paper by Bucekkine and
Ruiz-Tamarit [8]. In this paper the authors use a method which does not use
dimensional reduction.
The mathematical tool in analysing the dynamics of the Lucas-Uzawa models is
the Pontryagin optimization method. The reader may consult any of the known
references of this technique, like Malliaris and Brock [18], Pontryagin et. al. [24]
or Seierstad and Sydsaeter [30].
We use two different methods in obtaining closed-form solution to the models we
consider. The first method uses a procedure similar to the dimensional reduction.
However in our method we do not consider solutions along the balanced growth
path. The second method uses the procedure introduced by Bucekkine and Ruiz-
3
Tamarit [8]. However our line of reasoning is more transparent and will offer a
simple method of solving this kind of models.
The solution procedure of models with externalities uses quite different techniques
to those known so far. The closed-form solutions of the models with externalities
appear for the first time in the literature.
The closed-form solutions of the models considered is based on the evaluation of
the two integrals

t
0
0
s s
ds ) C e ( e and

+
t
0
t
0 1 2
t
dt ) e C ; 1 ; , ( F e
These two integrals are evaluated in Appendices A and B respectively, expressed
in terms of hypergeometric functions. The first one is expressed in terms of the
hypergeometric function () F
1 2
(Appendix A, equation (A.16)), while the second is
expressed in terms of the generalized hypergeometric function [] F
2 3
(Appendix
B, equation (B.11)). The evaluation of the first integral is based on the integral
representation of the hypergeometric function, while the second on an integral
formula of the generalized hypergeometric function, appearing in the existing
literature.
We should stress the fact that the paper does not examine in general growth
models. It only serves to introduce some standard methods in solving these
models. Especially the relation between BGP and exact solutions will be examined
in an expanded version of the paper (under preparation).
The paper is organized as follows:
In Section 2 we consider a simple model which is solved explicitly following two
methods. The first method of solution uses a type of dimensional reduction at the
beginning and then introducing two auxiliary functions, we find that these
functions satisfy a system of ordinary differential equations. After solving the
system, we can evaluate the function of the physical capital, the control variables
and then the human capital function. The second method uses the same steps
4
followed by Bucekkine and Ruiz-Tamarit. However all the intermediate steps are
made explicit in an easy to follow way. There is however a difference to the
expression for the human capital. According to our own calculations, the human
capital is expressed in terms of the generalized hypergeometric function [] F
2 3
.
In Section 3 we consider a simple model with externalities. The solution
procedures we follow are quite different compared to the methods considered in
the model of Section 2 and appear for the first time in the literature.
In Section 4 we solve the model considered by Bucekkine and Ruiz-Tamarit which
is again solved using two methods.
In section 5 we consider the model of Bucekkine and Ruiz-Tamarit equipped with
externalities. The methods used in Section 3 are used again in this model. We thus
conclude that the methods introduced in Section 3 can be applied to more
complicated models.
In Section 6 we consider and solve explicitly a model introduced by Ruiz-Tamarit
and Snchez-Moreno [29], on optimal regulation in a natural-resource-based
economy.
Finally in section 7 we consider some issues on optimal fiscal policy along the
lines of reasoning by Gmez [11].
A word of caution: The various parameters introduced in the text, like , , etc.,
are defined in different ways in the various Sections (or even in the various
subsections).
2. A simple Lucas-Uzawa model
2.0. The model.
We work with a Cobb-Douglas production function

1
) H u ( K A Y
where
5
A: represents the technological level of the economy, considered to be
constant
K: represents the stock of the physical capital
H: represents the stock of the human capital
u: is the portion of the human capital devoted to the production of output Y
The portion of the human capital devoted to the production of more human capital
will then be u 1 . This leads to the equation of motion for the human capital:
H ) u 1 ( ) t ( H
where is a constant coefficient.
The equation of motion of the physical capital is derived by the equation
C Y K where C is the consumption, or using the expression for Y,
C ) H u ( K A K
1

We consider the dynamic optimization problem
dt e
1
1 ) t ( C
max
t
0
1

(2.1)
subject to
) t ( C )) t ( H ) t ( u ( ) t ( K ) t ( K
1

(2.2)
) t ( H )) t ( u 1 ( ) t ( H (2.3)
with initial conditions

0
K ) 0 ( K ,
0
H ) 0 ( H (2.4)
where
0 ) t ( C , ] 1 , 0 [ ) t ( u , 0 ) t ( K , 0 ) t ( H (2.5)
In equation (2.1) we work with an isoelastic utility function and maximize the
integral, where is the instantaneous elasticity of substitution and is the
instantaneous discount rate. In equation (2.2) we have considered the case 1 A
for simplicity.
6
2.1. The equations of motion.
The current value Hamiltonian is given by
) K , H , u , C ( H
c
+ +

] ) t ( C )) t ( H ) t ( u ( ) t ( K [
1
1 ) t ( C
1
K
1
] ) t ( H )) t ( u 1 ( [
H
+ (2.6)
where
K
and
H
are the costate variables corresponding to K and H
respectively.
We can write down the dynamic equations of the model, using Pontryagins
optimization method. The reader may consult any of the known references of this
technique, like Malliaris and Brock [18], Pontryagin et. al. [24] or Seierstad and
Sydsaeter [30].
The first order conditions read
0 e C 0
C
H
K
t
c

(2.7)
0 ] H ) H u ( K ) 1 ( [ H 0
u
H
K H
c
+

(2.8)
We also have the two Euler equations
0 ) H u ( K 0
K
H
K
1 1
K K
c
+ +

(2.9)
+
0
H
H
H
c

0 H ) H u ( K ) 1 ( ) u 1 (
H
1 1
K H
+ +

(2.10)
the dynamic constraints
C ) H u ( K K
1

,
0
K ) 0 ( K (2.11)
7
H ) u 1 ( H ,
0
H ) 0 ( H (2.12)
and the transversality conditions
0 e K lim
t
K
t

(2.13)
0 e H lim
t
H
t

(2.14)
2.2. First method of solution.
This method uses a procedure similar to the dimensional reduction. The derived
system however is not solved along the balanced growth path (BGP). Considering
two auxiliary functions, we get a system of decoupled first order ordinary
differential equations, which, when solved, determine the physical capital, the
control variable u and finally the human capital.
2.2.1. Simplification of the dynamical equations.
Taking logarithms and differentiation with respect to time, we obtain from
equation (2.7) that

K
K
C
C

(2.15)
Similarly, taking logarithms and differentiation with respect to time, we obtain
from equation (2.8) that

H
H
K
K
H
H
u
u
K
K

(2.16)
From equation (2.9) we obtain

1 1
K
K
) H u ( K
(2.17)

H
1
) H u ( K ) 1 ( ) u 1 (
H
K 1
H
H

(2.18)
8

K
C
) H u ( K
K
K
1 1

(2.19)
) u 1 (
H
H
(2.20)
We introduce a function named Y defined by

1
) H u ( K Y (2.21)
Equations (2.17)-(2.19) can be expressed in terms of the function Y as follows:

K
Y
K
K

(2.22)

H
Y
) 1 ( ) u 1 (
H
K
H
H
(2.23)

K
C
K
Y
K
K
(2.24)
From equation (2.8) we find that
u
1 H
Y
H
K

(2.25)
Because of the previous relation, we can simplify further equation (2.23):

H
H
(2.26)
Combining equations (2.15) and (2.22) we find an expression for the ratio

K
Y
C
C
(2.27)
Equation (2.16), upon substituting the expressions for
K
K
,
K
K
,
H
H
and
H
H
given
by (2.22), (2.24), (2.20) and (2.26) respectively, we obtain the equation

K
C
u
) 1 (
u
u
+

(2.28)
9
2.2.2. Auxiliary Functions and their Differential Equations.
We now introduce two more functions U and Z defined by

K
Y
U (2.29)
and

K
C
Z (2.30)
respectively.
We shall establish a system of two ordinary differential equations satisfied by
these two functions.
Taking logarithms and differentiation of the defining equations (2.29) and (2.30),
we obtain the equations

K
K
Y
Y
U
U

(2.31)
and

K
K
C
C
Z
Z

(2.32)
respectively.
We can express the right hand sides of the two previous equations in terms of the
functions U and Z. From equation (2.24) we obtain
Z U
K
K
(2.33)

U
C
C
(2.34)
We now have to express the ratio
Y
Y
in terms of U and Z. Taking logarithms and
differentiation of (2.21), we obtain the equation
10

H
H
) 1 (
u
u
) 1 (
K
K
Y
Y

+ + (2.35)
Substituting the ratios
K
K
,
u
u
and
H
H
given by (2.33), (2.28) and (2.20)
respectively into the previous equation, we obtain

+
) 1 (
Z U
Y
Y
(2.36)
Therefore we obtain from (2.31) and (2.32), using (2.36), (2.33) and (2.34), the
system of two equations
U ) 1 (
) 1 (
U
U

(2.37)
and

+ U Z
Z
Z
(2.38)
Equation (2.37) can be solved by separation of variables. The solution is given by

0
t
t
C e
e
U
(2.39)
where

) 1 (
and
) 0 ( U
1 C
0
(2.40)
Using the expression (2.39) for the function U, equation (2.38) is converted into
the equation

2
0
t
t
Z Z
C e
e
) 1 (
Z
,
`
.
|
(2.41)
This is a Bernoulli differential equation, solved under the substitution

1
Z X

(2.42)
Equation (2.41) is converted in terms of X into the linear differential equation
11
1 X
C e
e
) 1 (
X
0
t
t

,
`
.
|
(2.43)
The integrating factor of the above equation is

) C e ( e ) t ( I
0
t t
(2.44)
where

and
) 1 (

(2.45)
Multiplying (2.43) by the integrating factor, we obtain the equation

) C e ( e ) X ) t ( I (
dt
d
0
t t
which, upon integration in the interval ] t , 0 [ , gives
ds ) C e ( e ) 0 ( X ) 0 ( I X ) t ( I
t
0
0
s s

(2.46)
The integral on the right hand side of the previous equation is calculated in
Appendix A. We have, using the notation of this section
) t (
1
ds ) C e ( e
t
0
0
s s

(2.47)
where
) C ; 1 ; , ( F ) e C ; 1 ; , ( F e ) t (
0
t
0
t
+ +

(2.48)
and

+
(2.49)
Therefore we obtain from (2.46) the following expression for the function X:

) C e ( e
) t (
1
) 0 ( X ) C 1 (
X
0
t t
0
(2.50)
We thus have that the function Z related to X by (2.42) is given by
12

) t (
1
) 0 ( X ) C 1 (
) C e ( e
Z
0
0
t t

(2.51)
Since from (2.47) we have upon differentiation with respect to t the relation

,
`
.
|

) t (
1
dt
d
) C e ( e
0
t t
(2.52)
equation (2.51) is written as

W
W
Z

(2.53)
where
) t (
1
) 0 ( X ) C 1 ( W
0

+

(2.54)
On the other hand, equation (2.39) can be expressed as

V
V
1
1
U

(2.55)
where

0
t
C e V

(2.56)
2.2.3. Equation for the physical capital.
Equation (2.33) can be written, because of (2.55) and (2.53), as

W
W
V
V
1
1
K
K

+

(2.57)
The above equation can be integrated once, providing us with the following
expression for the physical capital
W V D K
1
1
0

or

'
'
) t (
1
) 0 ( X ) C 1 ( ) C e ( D ) t ( K
0
1
1
0
t
0
(2.58)
13
where

'
'

) 0 (
1
) 0 ( X ) C 1 ( ) C 1 (
K
) 0 ( W ) 0 ( V
K
D
0
1
1
0
0
1
1
0
0
(2.59)
2.2.4. Equation for the control variable u.
From equation (2.28), using (2.30) and (2.53), we derive the equation

W
W
u
) 1 (
u
u

+ +
which is equivalent to the equation

2
u u
W
W ) 1 (
u
,
`
.
|
+

(2.60)
This is a Bernoulli differential equation, which under the substitution

1
u y

(2.61)
becomes a linear first order differential equation

,
`
.
|
+

+ y
W
W ) 1 (
y

(2.62)
The previous equation admits the integrating factor
W e ) t ( J
t
(2.63)
Multiplying equation (2.62) by the integrating factor, we obtain the equation
W e ) y ) t ( J (
dt
d
t

which, upon integration in the interval ] t , 0 [ , gives us

t
0
t
ds ) s ( W e ) 0 ( y ) 0 ( J y ) t ( J (2.64)
Let

t
0
t
ds ) s ( W e ) t ( X (2.65)
14
Using the expression (2.54), we find that

t
0
s
ds ) s ( W e ) t ( X
+
'
'

t
0
s
0 0
ds e ) C ; 1 ; , ( F
1
) 0 ( X ) C 1 (
+
t
0
s
0
s ) 1 (
ds ) e C ; 1 ; , ( F e
1
(2.66)
The last integral is evaluated in Appendix B. We get from (B.16), using the
notation of this section,
+

t
0
t
0
t
dt ) e C ; 1 ; , ( F e

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
1
(2.67)
where
) 1 ( and
p (2.68)
Therefore we have the following expression for the function ) t ( X :

t
0
s
ds ) s ( W e ) t ( X

,
`
.
|
'
'
1 e
) C ; 1 ; , ( F
1
) 0 ( X ) C 1 (
t
0 0
'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
2
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
1
(2.69)
We then obtain from (2.64)

) t ( J
) t ( X ) 0 ( y ) 0 ( J
y

(2.70)
and then
15

) t ( X ) 0 ( y ) 0 ( J
) t ( J
) t ( u

(2.71a)
or, comparing (2.63) and (2.65),

) t ( X ) 0 ( y ) 0 ( J
) t ( X
) t ( u

(2.71b)
2.2.5. Equation for the human capital.
Equation (2.20) for the human capital, because of the previous expression (2.71),
takes on the form

) t ( X ) 0 ( y ) 0 ( J
) t ( X
H
H

+

or even

S
S
H
H

+ (2.72)
where
) t ( X ) 0 ( y ) 0 ( J ) t ( S (2.73)
Equation (2.72) gives upon integration

t 0
e ) t ( S
) 0 ( S
H
) t ( H

(2.74)
2.3. Second method of solution.
The second method of solution follows the procedure introduced by Bucekkine
and Ruiz-Tamarit [8]. The intermediate steps however are more transparent and
the overall method provides a standard algorithmic procedure. On the other hand
there is a difference in the human capital evaluation. In our calculation the human
capital is expressed in terms of generalized hypergeometric functions.
2.3.1. Equations for the control variables.
Solving equation (2.7) with respect to C, we obtain
16

,
`
.
|

1
K
) ( t exp C (2.75)
Solving equation (2.8) with respect to u, we obtain

H
K
1
u
1
H
K
1
,
`
.
|
,
`
.
|

(2.76)
We also get from the previous relation that

,
`
.
|
,
`
.
|

1
1
H
K
1
1
K
1
) H u ( (2.77)
we shall need later on.
2.3.2. Equations for the costate variables.
Equation (2.10), because of (2.76) and (2.77), takes on the form
0
H H
+ (2.78)
Equation (2.78) admits the general solution

t
H H
e ) 0 (

(2.79)
Equation (2.9), because of (2.77), becomes
0
1
K
1
H
K
1
K

,
`
.
|
,
`
.
|

(2.80)
This equation, written as (because of (2.79))

,
`
.
|
,
`
.
|

1
K
1
1
H
1
K
) ( t
) 1 (
exp )) 0 ( (
1
is an equation with separable variables with general solution

C t
) 1 (
exp ) 0 (
1
) (
1
H
1
K
+
,
`
.
|
,
`
.
|
(2.81)
where C is a constant to be determined from the initial conditions. For 0 t we
obtain from the above equation
17
C ) 0 (
1
)) 0 ( (
1
H
1
K
+
,
`
.
|
from which we determine the constant C. Therefore equation (2.81) takes the final
form
+
,
`
.
|
,
`
.
|
t
) 1 (
exp ) 0 (
1
) (
1
H
1
K

,
`
.
|
+
1
H
1
K
) 0 (
1
)) 0 ( ( (2.82)
The previous equation can also be written as

,
`
.
|
1
H
1
K
) 0 (
1
) (

'
'
,
`
.
|
,
`
.
|
1
) 0 (
) 0 ( 1
t
) 1 (
exp
1
H
K
or
) C e ( ) 0 (
1
) (
0
t
1
H
1
K

,
`
.
|
(2.83)
where we have introduced the notation

) 1 (
(2.84)
and

,
`
.
|

1
H
K
0
) 0 (
) 0 ( 1
1 C (2.85)
We thus obtain from (2.83) the following expression for the costate variable
K
:
18

,
`
.
|

1
0
t
H
1
K
) C e ( ) 0 (
1
(2.86)
We now consider equation (2.11). This equation, because of (2.77) and (2.75),
takes the form

,
`
.
|
,
`
.
|
,
`
.
|

t exp ) ( K
1
K
1
K
1
H
K
1
(2.87)
In order to simplify the above expression, we need to find the ratio of the costate
variables. Using the expressions (2.86) and (2.79), we obtain

0
t
t
1
1
H
K
C e
e
1

,
`
.
|

,
`
.
|

(2.88)
Equation (2.87), taking into account (2.88) and (2.86), takes on the form
,
`
.
|
t exp ) C e ( A K
C e
e
1
1
K
) 1 (
0
t
0
t
t
(2.89)
where A is a constant defined by

,
`
.
|
,
`
.
|
1
H
) 1 (
) 0 (
1
A (2.90)
We come now to the solution of (2.89), which is a linear first order differential
equation, with integrating factor

,
`
.
|

1
1
0
t
0
t
t
) C e ( dt
C e
e
1
1
exp ) t ( I (2.91)
Multiplying equation (2.89) by the integrating factor ) t ( I , we find

,
`
.
|
t exp ) C e ( A )) t ( I ) t ( K (
dt
d
1
1
) 1 (
0
t
19
and integrating in the interval ] t , 0 [ , we arrive at the equation

,
`
.
|

t
0
1
1
) 1 (
0
s
0
ds ) C e ( s exp A ) 0 ( I K ) t ( I ) t ( K (2.92)
Introducing the notation

1
1
) 1 (
and
(2.93)
equation (2.92) becomes

t
0
0
s s
1
1
0 0
1
1
0
t
ds ) C e ( e A ) C 1 ( K ) C e ( ) t ( K (2.94)
The integral appearing in (2.94) is not elementary. It can be evaluated using the
hypergeometric function, known from the theory of differential equations in the
complex domain. All the relevant calculations appear in Appendix A. We have
found (see equation (A.16))

t
0
0
s s
ds ) C e ( e
] ) e C ; 1 ; , ( F ) e C ; 1 ; , ( F e [
1
t
0
t
0
t
+ +
(2.95)
We are now in a position to write down the final expression for the function ) t ( K
using (2.94), (2.91) and (2.95):
) t (
A
) C 1 ( K ) C e ( ) t ( K
1
1
0 0
1
1
0
t
(2.96)
where
) C ; 1 ; , ( F ) e C ; 1 ; , ( F e ) t (
0
t
0
t
+ +

(2.97)
From equation (2.96) we obtain the final expression for the physical capital:

,
`
.
|

+
1
1
0
t
1
1
0 0
) C e ( ) t (
A
) C 1 ( K ) t ( K (2.98)
20
We come now in finding an explicit solution of the differential equation (2.12) for
the human capital. Substituting into (2.12) the expression for u given by (2.76),
we obtain the following differential equation
K
1
H H
1
H
K
1
,
`
.
|
,
`
.
|

(2.99)
From (2.88) we obtain

,
`
.
|

,
`
.
|

,
`
.
|
,
`
.
|
1
1
0
t
1
1
1
1
H
K
) C e ( t
1
exp
1
Using the previous expression and also (2.98) for K, we get the following
differential equation for H:
H H
,
`
.
|
,
`
.
|
,
`
.
|

) t (
A
) C 1 ( K t exp
1
1
0 0
1
1
(2.100)
This is a linear first order differential equation with integration factor

t
e ) t ( J

Therefore it can be written as

,
`
.
|

+
,
`
.
|
,
`
.
|

,
`
.
|

) t (
A
) C 1 ( K t exp ) H e (
dt
d
1
1
0 0
1
1
t
(2.101)
Integrating the previous formula in the interval ] t , 0 [ , we obtain

,
`
.
|
,
`
.
|

t
0
1
1
0 0
t
1
1
0
t
dt ) t (
A
) C 1 ( K e H ) t ( H e (2.102)
Using the expression for the function ) t ( , given in (2.97), equation (2.102) can
be transformed into the equation
21

0
t
H ) t ( H e
'
,
`
.
|
+

,
`
.
|

t
0
t
0
1
1
0 0
1
1
dt e ) C ; 1 ; , ( F
A
) C 1 ( K
'
+

t
0
t
0
t ) 1 (
dt ) e C ; 1 ; , ( F e
A
(2.103)
The last integral is not elementary and needs to be evaluated using some results
from the theory of Generalized Hypergeometric Functions. We put the integral
into the form

+
t
0
t
0
t
dt ) e C ; 1 ; , ( F e (2.104)
where
) 1 ( (2.105)
The integral has been evaluated in Appendix B. We have found (see equation
(B.11))
+

t
0
t
0
t
dt ) e C ; 1 ; , ( F e

]
]
]
+ +

+
]
]
]
+ +

0 2 3
t
0 2 3
t
C
1 , 1 p
, , p
F
p
1
e C
1 , 1 p
, , p
F e
p
1
(2.106)
where the parameter p is defined by
p .
Therefore from (2.103), using (2.104) and (2.106), we arrive at the following final
expression for the function ) t ( H :
'
'
,
`
.
|
) t ( X H e ) t ( H
1
1
0
t
(2.107)
where ) t ( X is given by
22
+
,
`
.
|
+

t
0
t
0
1
1
0 0
dt e ) C ; 1 ; , ( F
A
) C 1 ( K ) t ( X
+
+

t
0
t
0
t ) 1 (
dt ) e C ; 1 ; , ( F e
A

,
`
.
|
,
`
.
|
+

1 e
) C ; 1 ; , ( F
A
) C 1 ( K
t
0
1
1
0 0

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
2
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
A
(2.108)
2.3.5. Expressions for the control variables.
It is now easy to find the expressions of the control variables ) t ( u and ) t ( C
using the functions we have already found.
The control variable ) t ( C is given by (2.75). Substituting into this expression the
K
given by (2.86), we obtain

,
`
.
|
,
`
.
|
,
`
.
|
t exp ) C e ( ) 0 (
1
) t ( C
) 1 (
0
t
) 1 (
1
H
(2.109)
Using (2.76) for the control variable ) t ( u , we first find the ratio
H
K
from (2.88)
and then substitute the expressions for K and H from (2.98) and (2.107)
respectively. We have

) t ( X H
) t (
A
) C 1 ( K
t
1
exp ) t ( u
1
1
0
1
1
0 0
1
1

,
`
.
|

+

,
`
.
|
,
`
.
|

,
`
.
|
(2.110)
where all the functions and parameters are defined in the text.
23
3. A Lucas-Uzawa model with externalities.
3.0. The model.
We work with a Cobb-Douglas production function

1
) L H u ( K A Y
where
A: represents the technological level of the economy, considered to be
constant
K: represents the stock of the physical capital
L: represents the labour, considered to be constant
H: represents the stock of the human capital
u: is the portion of the human capital devoted to the production of output Y
Therefore uHL represents the amount of labour used to produce output.
Externality is introduced to the model in the form of average schooling of the
human capital. We thus introduce the production function

a
1
H ) L H u ( K A Y
where
a
H is the measure of the externality.
The physical capital, ignoring depreciation, is expressed by
C H ) HL u ( K A K
a
1

where C is the consumption. Considering L constant, and dividing through by L,
we can write the previous equation in per capita terms (retaining the notation)
C H ) H u ( K A K
a
1

In equilibrium condition, we have H H
a
.
The portion of the human capital devoted to the production of more human capital
will then be u 1 . This leads to the equation of motion for the human capital:
H ) u 1 ( ) t ( H
24
where is a constant coefficient.
dt e
1
1 ) t ( C
max
t
0
1

(3.1)
subject to
) t ( C ) t ( H )) t ( H ) t ( u ( ) t ( K A ) t ( K
1

(3.2)
) t ( H )) t ( u 1 ( ) t ( H (3.3)

0
K ) 0 ( K ,
0
H ) 0 ( H (3.4)
where
0 ) t ( C , ] 1 , 0 [ ) t ( u , 0 ) t ( K , 0 ) t ( H (3.5)
In equation (3.1) we work again with an isoelastic utility function and maximize
the integral, where is the instantaneous elasticity of substitution and is the
instantaneous discount rate.
) K , H , u , C ( H
c
+ +

] ) t ( C ) t ( H )) t ( H ) t ( u ( ) t ( K A [
1
1 ) t ( C
1
K
1
] ) t ( H )) t ( u 1 ( [
H
+ (3.6)
where
K
and
H
respectively.
optimization method. The reader may consult any of the known references of this
technique, like Malliaris and Brock [18], Pontryagin et. al. [24] or Seierstad and
Sydsaeter [30].
25
0 C 0
C
H
K
c

(3.7)
0 H ] H ) H u ( K A ) 1 ( [ 0
u
H
H
1
K
c

+
(3.8)
K K
1 1
K K K
c
H ) H u ( AK
K
H
+ +

(3.9)
+
H H
c
H
H

H H H
1 1
K
) u 1 ( H ) H u ( K A ) 1 ( + + +

(3.10)
C H ) H u ( K A K
1

,
0
K ) 0 ( K (3.11)
H ) u 1 ( H ,
0
H ) 0 ( H (3.12)
0 e K lim
t
K
t

(3.13)
0 e H lim
t
H
t

(3.14)
3.2. First method of solution to the model.
This method uses a procedure similar to the dimensional reduction. The derived
system however is not solved along the balanced growth path (BGP). Considering
two auxiliary functions, we get a system of decoupled ordinary first order
differential equations, which, when solved, determine the physical capital, the
control variable u and finally the human capital.
26
equation (3.7) that

K
K
C
C

(3.15)
equation (3.8) that

H
H
K
K
H
H
) (
u
u
K
K
+ +

(3.16)

H ) H u ( AK
1 1
K
K
(3.17)

H
K 1 1
H
H
H ) H u ( AK ) 1 ( ) u 1 (

(3.18)

K
C
H ) H u ( AK
K
K
1 1

(3.19)
) u 1 (
H
H
(3.20)

H ) H u ( AK Y
1
(3.21)

K
Y
K
K

(3.22)

H
Y
) 1 ( ) u 1 (
H
K
H
H
(3.23)
27

K
C
K
Y
K
K
(3.24)
u
1 H
Y
H
K

(3.25)
u
1
) 1 (
) u 1 (
H
H
(3.26)

K
Y
C
C
(3.27)
Equation (3.16), upon substituting the expressions for
K
K
,
K
K
,
H
H
and
H
H
given
by (3.22), (3.24), (3.20) and (3.26) respectively, we obtain the equation

K
C
u
1
) 1 ( ) 1 (
u
u

+
+
+
(3.28)
3.2.2. Auxiliary functions and their differential equations.

K
Y
U (3.29)
and

K
C
Z (3.30)
respectively.
28

K
K
Y
Y
U
U

(3.31)
and

K
K
C
C
Z
Z

(3.32)
respectively.
Z U
K
K
(3.33)

U
C
C
(3.34)
Y
Y

H
H
) 1 (
u
u
) 1 (
K
K
Y
Y

+ + + (3.35)
K
K
,
u
u
and
H
H
given by (3.33), (3.28) and (3.20)

+
+
) 1 (
Z U
Y
Y
(3.36)
U ) 1 (
) 1 (
U
U

+
(3.37)
and
29

+ U Z
Z
Z
(3.38)

0
t
t
C e
e
1
1
U
(3.39)
where

+

) 1 (
and
) 0 ( U ) 1 (
) 1 (
1 C
0

+
(3.40)
the equation

2
0
t
t
Z Z
C e
e
) 1 (
Z
,
`
.
|
(3.41)

1
Z X

(3.42)
1 X
C e
e
) 1 (
X
0
t
t

,
`
.
|
(3.43)

) C e ( e ) t ( I
0
t t
(3.44)
where

and
) 1 (

(3.45)

) C e ( e ) X ) t ( I (
dt
d
0
t t
30
ds ) C e ( e ) 0 ( X ) 0 ( I X ) t ( I
t
0
0
s s

(3.46)
) t (
1
ds ) C e ( e
t
0
0
s s

(3.47)
where
) C ; 1 ; , ( F ) e C ; 1 ; , ( F e ) t (
0
t
0
t
+ +

(3.48)
and

+
(3.49)

) C e ( e
) t (
1
) 0 ( X ) C 1 (
X
0
t t
0
(3.50)
We thus have that the function Z, related to X by (3.42), is given by

) t (
1
) 0 ( X ) C 1 (
) C e ( e
Z
0
0
t t

(3.51)
Since from (3.47) we have upon differentiation with respect to t the relation

,
`
.
|

) t (
1
dt
d
) C e ( e
0
t t
(3.52)

W
W
Z

(3.53)
where
) t (
1
) 0 ( X ) C 1 ( W
0

+

(3.54)
31

V
V
1
1
U

(3.55)
where

0
t
C e V

(3.56)

W
W
V
V
1
1
K
K

+

(3.57)
W V D K
1
1
0

or

'
'
) t (
1
) 0 ( X ) C 1 ( ) C e ( D ) t ( K
0
1
1
0
t
0
(3.58)
where

'
'

) 0 (
1
) 0 ( X ) C 1 ( ) C 1 (
K
) 0 ( W ) 0 ( V
K
D
0
1
1
0
0
1
1
0
0
(3.59)

W
W
u
1
) 1 ( ) 1 (
u
u

+

+
+

2
u
1
) 1 (
u
W
W ) 1 (
u

+
,
`
.
|
+

(3.60)
32

1
u y

(3.61)

+

,
`
.
|
+
+
+
1
) 1 (
y
W
W ) 1 (
y

(3.62)
W e ) t ( J
t
(3.63)
W e
1
) 1 (
) y ) t ( J (
dt
d
t

+


+

t
0
t
ds ) s ( W e
1
) 1 (
) 0 ( y ) 0 ( J y ) t ( J (3.64)
Let

t
0
t
ds ) s ( W e ) t ( X (3.65)

t
0
s
ds ) s ( W e ) t ( X
+
'
'

t
0
s
0 0
ds e ) C ; 1 ; , ( F
1
) 0 ( X ) C 1 (
+
t
0
s
0
s ) 1 (
ds ) e C ; 1 ; , ( F e
1
(3.66)
+

t
0
t
0
t
dt ) e C ; 1 ; , ( F e
33

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
1
(3.67)
where
) 1 ( and
p (3.68)

t
0
s
ds ) s ( W e ) t ( X

,
`
.
|
'
'
1 e
) C ; 1 ; , ( F
1
) 0 ( X ) C 1 (
t
0 0
'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
2
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
1
(3.69)

) t ( J
) t ( X ) 0 ( y ) 0 ( J
y

(3.70)
and then

) t ( X ) 0 ( y ) 0 ( J
) t ( J
) t ( u

(3.71)
where we have put

+

1
) 1 (
(3.72)
Equation (3.71) can also be written, comparing (3.63) and (3.65), as

) t ( X ) 0 ( y ) 0 ( J
) t ( X
u

(3.73)
Equation (3.20) for the human capital, because of the previous expression, takes
on the form
34

) t ( X ) 0 ( y ) 0 ( J
) t ( X
H
H

+

or even

S
S
H
H

+ (3.74)
where
) t ( X ) 0 ( y ) 0 ( J S (3.75)

t 0
e S
) 0 ( S
H
H

or

t 1
1
1
1
0
e ) t ( S
) 0 ( S
H
) t ( H
+

+

(3.76)
3.3. Second method of solution to the model.

1
K
) ( C (3.77)

,
`
.
|
,
`
.
|

H K
A ) 1 (
u
1
H
K
1
(3.78)

,
`
.
|
,
`
.
|
) 1 (
1
1
H
K
1
1
H K
A ) 1 (
) H u ( (3.79)
35
Equation (3.9), because of (3.79), takes on the form

H
1
H
K
1
K K
H
A ) 1 (
A
,
`
.
|
,
`
.
|
(3.80)
Equation (3.10), because of (3.78) and (3.79), becomes

H
1
H
K
1
H H
K H
A ) 1 (
A ) (
,
`
.
|
,
`
.
|
(3.81)
We now consider equation (3.11). This equation, because of (3.79), takes the form

,
`
.
|
,
`
.
|
1
K
1
H
K
1
) ( K H
A ) 1 (
A K (3.82)
Substituting into (3.12) the expression for u given by (3.78), we obtain the
following differential equation
K H
A ) 1 (
H H
1
H
K
1
,
`
.
|
,
`
.
|

(3.83)
3.3.5. The solution strategy.
It is now evident the solution strategy we have to follow to solve the system of the
four previous equations (3.80)-(3.83).
3.3.5.1. Relation between H and
H
Dividing equation (3.81) by equation (3.83), we obtain

H 1 H H
) (
H H H

(3.84)
The previous equation can be written as
36
0
H
H H
1
) (
H
H H
+

or equivalently

H
H
1
H
H

(3.85)
where
+

1
(3.86)
Integrating equation (3.85), we get

t 1
0 H
e ) t ( H C ) t (

(3.87)
where

1
H
0
) 0 ( H
) 0 (
C (3.88)
3.3.5.2. Expression for the costate variable
K
.
Using the above expression for
H
into the equation (3.80) for
K
, we get the
equation
,
`
.
|

1
K 0 K K
) (
) 1 (
exp B (3.89)
where

,
`
.
|

1
0
0
C
A ) 1 (
A B (3.90)
Equation (3.89) is a Bernoulli differential equation. Multiplying both members of
this equation by
1
K
) ( and introducing a new function by

1
1
K
) ( , we
obtain the linear first order differential equation
37

,
`
.
|
,
`
.
|

+
) 1 (
exp B
1 ) 1 (
0
(3.91)
The above differential equation is found to admit a solution given by

,
`
.
|
,
`
.
|
,
`
.
|
,
`
.
|

t
) 1 (
exp ) 0 (
B
) (
1 t
) 1 ( ) (
exp
B
0
0
Therefore
,
`
.
|
,
`
.
|
,
`
.
|
1
K
0
0
1
1
K
)) 0 ( (
B
) (
1 t
) 1 ( ) (
exp
B
) (

,
`
.
|

t
) 1 (
exp
from which we obtain the following expression for the costate variable
K
:

t
1
0
t
1
0
K
e ) D e (
B

,
`
.
|

(3.92)
where

) 1 ( ) (
(3.93)
and

1
K
0
0
)) 0 ( (
B
) (
1 D (3.94)
3.3.5.3. Equation for the physical capital.
Equation (3.82) for the physical capital, because of the (3.87), gets simplified into
the equation

,
`
.
|
,
`
.
|
1
K
1
K
1
0
) ( K
) 1 (
exp ) (
C
A ) 1 (
A K
and because of (3.92), into
38
,
`
.
|
,
`
.
|

K
D e
e
B C
A ) 1 (
A K
0
t
t
0
1
0
,
`
.
|
,
`
.
|

t exp ) D e (
B
) 1 (
0
t
) 1 (
0
(3.95)
We obtain that

,
`
.
|
,
`
.
|

1 B C
A ) 1 (
A
0
1
0
(3.96)
We also introduce the notation
) 1 (
0
0
B
F

,
`
.
|

(3.97)
and

(3.98)
Equation (3.95) then becomes

t ) 1 (
0
t
0
0
t
t
e ) D e ( F K
D e
e
1
1
K

(3.99)
Equation (3.99) is a linear first order differential equation with integrating factor
given by

,
`
.
|

1
1
0
t
0
t
t
) D e ( dt
D e
e
1
1
exp ) t ( I (3.100)
Therefore equation (3.99), after multiplying by the integrating factor, becomes

1
1
) 1 (
0
t t
0
) D e ( e F ) K ) t ( I (
dt
d
Integrating the above equation we arrive at
39
dt ) D e ( e F K ) 0 ( I K ) t ( I
t
0
0
t t
0 0

(3.101)
where

) 1 ( 1
1
) 1 (

(3.102)
The integral appearing in (3.101) is evaluated to be (Appendix A)

dt ) D e ( e
t
0
0
t t
'
'

1
0
0
1
1
0
t
0
1 t
du ) u D 1 ( u dx ) x e D 1 ( x e
1

) t (
1
(3.103)
where
) D ; 1 ; , ( F ) e D ; 1 ; , ( F e ) t (
0
t
0
t
+ +

(3.104)

+
(3.105)
Using (3.101), (3.103) and the explicit expression for the integrating factor ) t ( I
given by (3.100), we obtain the following expression for the human capital:

,
`
.
|
+
1
1
0
t 0
0
1
1
0
) D e ( ) t (
F
K ) D 1 ( ) t ( K (3.106)
3.3.5.4. Equation for the human capital.
We now turn to the evaluation of the human capital using equation (3.83). This
equation can be written, using (3.87) and (3.92), as

,
`
.
|

,
`
.
|
1
1
0
t
1
1
0
1
0
) D e (
B
C
A ) 1 (
H H
40
K H t exp
1
,
`
.
|

(3.107)
The previous equation, using the expression (3.106) for the physical capital, takes
the form
,
`
.
|

t
1
exp G H H
0

,
`
.
|
+
1
0
0
1
1
0
H ) t (
F
K ) D 1 ( (3.108)
where

,
`
.
|

,
`
.
|

1
1
0
1
0
0
B
C
A ) 1 (
G (3.109)
Equation (3.108) is a Bernoulli differential equation. Multiplying through by

1
H , we obtain the equation
,
`
.
|

t
1
exp G H H H
0
1
1
1

,
`
.
|
) t (
F
K ) D 1 (
0
0
1
1
0
(3.110)
Introducing a new function U by

1
1
H U (3.111)
we obtain from (3.110) the equation
,
`
.
|

+

+
t
1
exp G
1
1
U
1
) 1 (
U
0

,
`
.
|
) t (
F
K ) D 1 (
0
0
1
1
0
(3.112)
41
The integrating factor is given by

,
`
.
|

+
t
1
) 1 (
exp ) t ( J
Therefore multiplying (3.112) by the integrating factor, we derive the equation
| )
,
`
.
|
+

+

) t (
F
K ) D 1 ( e G
1
1
U ) t ( J
dt
d
0
0
1
1
0
t
0
(3.113)
where

+

1
) 1 (
1
(3.114)
Integrating (3.113), we obtain

,
`
.
|
+

+

t
0
0
0
1
1
0
t
0 0
dt ) t (
F
K ) D 1 ( e G
1
1
U U ) t ( J (3.115)
We have further
,
`
.
|
t
0
0
0
1
1
0
t
dt ) t (
F
K ) D 1 ( e
+
,
`
.
|
+
t
0
t
0
0
0
1
1
0
dt e ) D ; 1 ; , ( F
F
K ) D 1 (
+
t
0
t
0
t ) ( 0
dt ) e D ; 1 ; , ( F e
F
(3.116)
We have the following formula (Appendix B)
+

t
0
t
0
t ) (
dt ) e D ; 1 ; , ( F e

]
]
]
+ +

+
]
]
]
+ +

0 2 3
t
0 2 3
t
D
1 , 1 p
, , p
F
p
1
e D
1 , 1 p
, , p
F e
p
1
(3.117)
where
42
and
p (3.118)
Therefore (3.115), because of (3.116) and (3.117), takes the form
,
`
.
|

+
'
'

+
t
1
) 1 (
exp ) t ( X G
1
1
U U
0 0
(3.119)
where

,
`
.
|
t
0
0
0
1
1
0
t
dt ) t (
F
K ) D 1 ( e ) t ( X

,
`
.
|
+
1 e
) D ; 1 ; , ( F
F
K ) D 1 (
t
0
0
0
1
1
0

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
2
0
D
1 , 1 p
, , p
F e D
1 , 1 p
, , p
F e
p
F
(3.120)
We thus obtain the following formula for the human capital

t
1
1
0
1
1
e ) t ( X G
1
1
) 0 ( H H

+

+
'
'

+
(3.121)
taking into account the relation (3.111) between H and U.
3.3.5.5. Expression for the costate variable
H
.
Using equations (3.87) and (3.121), we are able to find the following expression
for the costate variable
H
:
t ) (
) 1 (
1
0
1
1
0 H
e ) t ( X G
1
1
) 0 ( H C
+
+

+
'
'

+
(3.122)
where
0
C is given by (3.88).
4. Application I.
43
(The model considered by Bucekkine and Ruiz-Tamarit).
In this Section we solve again the model considered by Bucekkine and Ruiz-
Tamarit [8]. This model is solved using the two methods we already used in
solving the simple model considered in Section 2. Despite the fact that in the
second method we use the same technique to that introduced in reference [8], we
present explicitly all the intermediate steps, in easy to follow calculations. Apart
from that, we have found that the human capital function is expressed in terms of
the generalized hypergeometric function [] F
2 3
.
4.0. The model.

t
0
1
e ) t ( N
1
1 ) t ( c
max

(4.1)
subject to
) t ( N ) t ( c ) t ( K )) t ( H ) t ( N ) t ( u ( ) t ( K A ) t ( K
1

(4.2)
) t ( H ) t ( H )) t ( u 1 ( ) t ( H (4.3)

0
K ) 0 ( K ,
0
H ) 0 ( H ,
0
N ) 0 ( N (4.4)
where
0 ) t ( c , ] 1 , 0 [ ) t ( u , 0 ) t ( K , 0 ) t ( H (4.5)
The notation in this model is as in previous models. In this model however has
been considered depreciation of physical capital ( is the coefficient of
depreciation) and depreciation of human capital ( is the coefficient of
depreciation). The function ) t ( N represents the population growth.
4.1. The dynamical equations.
) K , N , H , u , c ( H
c
44
+ +

] ) t ( N ) t ( c ) t ( K )) t ( H ) t ( N ) t ( u ( ) t ( K A [ ) t ( N
1
1 ) t ( c
1
K
1
] ) t ( H ) t ( H )) t ( u 1 ( [
H
+ (4.6)
where
K
and
H
respectively.
optimization method.

K
c
c 0
c
H

(4.7)
0 ] N ) H N u ( K A ) 1 ( [ 0
u
H
H K
c

(4.8)
+
K K
c
K
H

+
1 1
K K K
) H N u ( K A ) ( (4.9)
+
H H
c
H
H
) u 1 ( H ) N u ( K A ) 1 ( ) (
H
1
K H H
+

(4.10)
N c K ) H N u ( K A K
1

,
0
K ) 0 ( K (4.11)
H H ) u 1 ( H ,
0
H ) 0 ( H (4.12)
0 e K lim
t
K
t

(4.13)
0 e H lim
t
H
t

(4.14)
45
We also suppose that we have the exponential population growth (exogenous)
given by

t n
0
e N ) t ( N (4.15)
4.2. First method of solution.
equation (4.7) that

K
K
C
C

(4.16)
equation (4.8) that

H
H
K
K
H
H
N
N
) 1 (
u
u
K
K
+ +

(4.17)

+
1 1
K
K
) H N u ( K A
(4.18)

H
1
) H N u ( AK ) 1 ( ) u 1 (
H
K 1
H
H

(4.19)

K
C
N ) H N u ( K A
K
K
1 1

(4.20)
) u 1 (
H
H
(4.21)
n
N
N
(4.22)
46

1
) NH u ( K A Y (4.23)

K
Y
K
K
+
(4.24)

H
Y
) 1 ( ) u 1 (
H
K
H
H
(4.25)

K
C
N
K
Y
K
K
(4.26)
u
1 H
Y
H
K

(4.27)
+
H
H
(4.28)
Combining equations (4.16) and (4.24), we find an expression for the ratio

K
Y
C
C
(4.29)
From equation (4.17), upon substituting the expressions given by (4.24), (4.26),
(4.22) and (4.21), we obtain the equation

K
C
N u
) n ( ) 1 (
u
u
+
+ +
(4.30)

K
Y
U (4.31)
and
47

K
C N
Z (4.32)
respectively.

K
K
Y
Y
U
U

(4.33)
and

K
K
C
C
N
N
Z
Z

+ (4.34)
respectively.
Z U
K
K
+ (4.35)

U
C
C
(4.36)
Y
Y

H
H
) 1 (
N
N
) 1 (
u
u
) 1 (
K
K
Y
Y

+ + + (4.37)
K
K
,
u
u
and
H
H
given by (4.26), (4.30), (4.22) and (4.21)
respectively, into the previous equation, we obtain
48

]
]
]
+ +
+ + +
) n ( ) 1 (
n ) 1 ( Z U
Y
Y
(4.38)
d ) 1 ( U ) 1 (
U
U
+ (4.39)
and

+
+ +

+ n U Z
Z
Z
(4.40)
where

+ +
+ + +
n ) 1 (
n d (4.41)

0
t
t
C e
e
1
1
U
(4.42)
where
d ) 1 ( and
) 0 ( U
d
1 C
0
(4.43)
the equation

2
0
t
t
Z Z n
C e
e
) 1 (
Z
,
`
.
|
+
+ +
(4.44)

1
Z X

(4.45)
1 X n
C e
e
) 1 (
X
0
t
t

,
`
.
|
+
+ +
(4.46)
49

) C e ( e ) t ( I
0
t t
(4.47)
where

+
+ n and
) 1 (

(4.48)

) C e ( e ) X ) t ( I (
dt
d
0
t t
ds ) C e ( e ) 0 ( X ) 0 ( I X ) t ( I
t
0
0
s s

(4.49)
) t (
1
ds ) C e ( e
t
0
0
s s

(4.50)
where
) C ; 1 ; , ( F ) e C ; 1 ; , ( F e ) t (
0
t
0
t
+ +

(4.51)
and

+
(4.52)

) C e ( e
) t (
1
) 0 ( X ) C 1 (
X
0
t t
0
(4.53)

) t (
1
) 0 ( X ) C 1 (
) C e ( e
Z
0
0
t t

(4.54)
Since from (4.50), we have upon differentiation with respect to t the relation
50

,
`
.
|

) t (
1
dt
d
) C e ( e
0
t t
(4.55)

W
W
Z

(4.56)
where
) t (
1
) 0 ( X ) C 1 ( W
0

+

(4.57)

V
V
1
1
U

(4.58)
where

0
t
C e V

(4.59)
+

W
W
V
V
1
1
K
K

(4.60)

t 1
1
0
e W V D K

or

t
0
1
1
0
t
0
e ) t (
1
) 0 ( X ) C 1 ( ) C e ( D ) t ( K

'
'
+ (4.61)
where
51

'
'

) 0 (
1
) 0 ( X ) C 1 ( ) C 1 (
K
) 0 ( W ) 0 ( V
K
D
0
1
1
0
0
1
1
0
0
(4.62)

W
W
u
) n ( ) 1 (
u
u

+ +
+ +

2
u u
W
W ) n ( ) 1 (
u
,
`
.
|
+
+ +

(4.63)

1
u y

(4.64)

,
`
.
|
+
+ +
+ y
W
W ) n ( ) 1 (
y

(4.65)
W e ) t ( J
t
(4.66)
where

+ +

) n ( ) 1 (
(4.67)
W e ) y ) t ( J (
dt
d
t


t
0
t
ds ) s ( W e ) 0 ( y ) 0 ( J y ) t ( J (4.68)
Let
52

t
0
t
ds ) s ( W e ) t ( X (4.69)
Using the expression (4.57), with ) t ( given by (4.51), we find that

t
0
s
ds ) s ( W e ) t ( X
+
'
'

t
0
s
0 0
ds e ) C ; 1 ; , ( F
1
) 0 ( X ) C 1 (
+
t
0
s
0
s ) (
ds ) e C ; 1 ; , ( F e
1
(4.70)
+

t
0
t
0
t
dt ) e C ; 1 ; , ( F e

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
1
(4.71)
where
and
p (4.72)

t
0
s
ds ) s ( W e ) t ( X

,
`
.
|
'
'
1 e
) C ; 1 ; , ( F
1
) 0 ( X ) C 1 (
t
0 0
'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
2
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
1
(4.73)
53

) t ( J
) t ( X ) 0 ( y ) 0 ( J
y

(4.74)
and then

) t ( X ) 0 ( y ) 0 ( J
) t ( J
u

(4.75a)
or, comparing (4.66) and (4.69),

) t ( X ) 0 ( y ) 0 ( J
) t ( X
u

(4.75b)
Equation (4.21) for the human capital, because of the previous expression (4.75b),
takes on the form

) t ( X ) 0 ( y ) 0 ( J
) t ( X
H
H

+

or even

S
S
H
H

+ (4.76)
where
) t ( X ) 0 ( y ) 0 ( J ) t ( S (4.77)

t ) ( 0
e ) t ( S
) 0 ( S
H
) t ( H

(4.78)
4.3. Second method of solution.
Solving equation (4.7) with respect to c, we obtain

1
K
) ( c (4.79)
54

,
`
.
|
,
`
.
|
1
1
H
K
1
N
H
K A ) 1 (
u (4.80)
We also get from the previous relation the two relations

,
`
.
|
,
`
.
|
1
1
1
H
K
1
1
N K
A ) 1 (
) uNH ( (4.81)
and

1
1
1
1
H
K
1
1
H N K
A ) 1 (
) N u (

,
`
.
|
,
`
.
|

(4.82)

,
`
.
|

+
1
K
1
H
1
1
K K
) ( ) ( N A
A ) 1 (
) ( (4.83)
+
H H H
) (
,
`
.
|
,
`
.
|

1
1
1
H
K
1
k
N H K
A ) 1 (
A ) 1 (
,
`
.
|
,
`
.
|

+
1
1
H
K
1
H
N
H
K A ) 1 (

H H
) ( + (4.84)
since, as we can easily check, the other two terms cancel.

t ) (
H H
e ) 0 ( ) t (
+
(4.85)
55
Equation (4.83), using (4.15) and (4.85), takes the simplified form
+
K K
) (

,
`
.
|
+

,
`
.
|

1
K
1
H
1
0
) ( t
) n )( 1 (
exp )) 0 ( (
AN ) 1 (
A (4.86)

,
`
.
|

1
0
AN ) 1 (
A (4.87)
and

+

) n )( 1 (
(4.88)
equation (4.86) can also be written as

+
1
K
t
1
H K K
) ( e )) 0 ( ( ) ( (4.89)
Equation (4.89) is a Bernoulli differential equation. Multiplying through by
1
K
) ( , this equation becomes

t
1
H
1
1
K
1
K K
e )) 0 ( ( ) ( ) ( ) (

+ (4.90)
Introducing a new function by

1
1
K
) ( (4.91)
equation (4.90) takes on the form

t
1
H
e )) 0 ( (
) 1 ( ) )( 1 (

+
+ (4.92)
The previous equation admits the function
t
e
as an integrating factor, where

+

) )( 1 (
(4.93)
56
Therefore the general solution of (4.92) is given by
C e )) 0 ( (
) (
) 1 (
e
t ) (
1
H
t
+
+

+

(4.94)
For 0 t , we obtain from the previous equation the relation
C )) 0 ( (
) (
) 1 (
) 0 (
1
H
+
+

(4.95)
from which we determine the constant C.
Therefore equation (4.94) takes the form

t
1
H
t
1
H
e )) 0 ( (
) (
) 1 (
) 0 ( e )) 0 ( (
) (
) 1 (

,
`
.
|
+

+
+

The above equation, taking into account (4.91), can also be written as

+

t
1
H
1
K
e )) 0 ( (
) (
) 1 (
) (

'
'
,
`
.
|

+
+ +

+
1
H
K t ) (
) 0 (
) 0 (
) 1 (
) (
e 1
or, in equivalent form,

,
`
.
|
+

+ +
t
) ( ) 1 (
exp )) 0 ( (
n
) (
1
H
1
K

'
'
,
`
.
|
+ +
+
,
`
.
|
+ +
+

1
H
K
) 0 (
) 0 ( n
t
) n ( ) 1 (
exp 1
From the previous equation we get the following expression for the costate
variable
K
:
57

,
`
.
|
+ +
t ) (
H
1
K
e ) 0 (
n

'
'
,
`
.
|
+ +
+
,
`
.
|
+ +
+
1
1
H
K
) 0 (
) 0 ( n
t
) n ( ) 1 (
exp 1 (4.96)
This is an explicit expression for the costate variable
K
.
In subsequent calculations, we shall need a compact form of this equation. For this
purpose we introduce the notation

+ +

) n ( ) 1 (
(4.97)
and

,
`
.
|
+ +

1
H
K
0
) 0 (
) 0 ( n
1 C (4.98)
Therefore equation (4.96) takes on the compact form

,
`
.
|
+ +

1
0
t t ) (
H
1
K
) C e ( e ) 0 (
n
(4.99)
takes the form
N ) ( K K N
A ) 1 (
A K
1
K
1
1
H
K
1
,
`
.
|
,
`
.
|

(4.100)
In the above expression, we need to find the ratio of the costate variables.
Using the expressions (4.99) and (4.85), we get

1
0
t
1
H
K
) C e ( t
) ( ) 1 (
exp
n

,
`
.
|
,
`
.
|
+ +
,
`
.
|
(4.101)
58
Equation (4.100), taking into account (4.101) and (4.99), and also (4.15) for the
population, takes the form
,
`
.
|
+ +
,
`
.
|

n N A ) 1 (
A K
1
0

,
`
.
|
+ +

K K ) C e ( t
) n ( ) 1 (
exp
1
0
t
'
'
,
`
.
|
,
`
.
|
+ +
t n exp N )) 0 ( (
n
0
1
H
) 1 (

) 1 (
0
t
) C e (

(4.102)
We can simplify the above expression considerably using the previously defined
quantities. We thus find, using the expression (4.87) which defines and (4.97)
which defines , that

+ +
,
`
.
|
+ +
,
`
.
|

1
n n N A ) 1 (
A
1
0
and

t
e t
) n ( ) 1 (
exp

,
`
.
|
+ +
Therefore equation (4.102) takes on the form

'
'
,
`
.
|
,
`
.
|
t n exp ) C e ( D K
C e
e
1
1
K
) 1 (
0
t
0
0
t
t
(4.103)
where
0
1
H
) 1 (
0
N )) 0 ( (
n
D

,
`
.
|
+ +
(4.104)
Equation (4.103) admits the integrating factor
59

t 1
1
0
t
0
t
t
e ) C e ( dt
C e
e
1
1
exp ) t ( I

'
'
,
`
.
|

(4.105)
Multiplying equation (4.103) by the integrating factor ) t ( I , we find

'
'
,
`
.
|
+
+

t n exp ) C e ( D )) t ( I ) t ( K (
dt
d
1
1
) 1 (
0
t
0

t
0
m
0
s s
0 0
ds ) C e ( e D ) 0 ( I K ) t ( I ) t ( K (4.106)
where

+
+ n (4.107)
and

1
1
) 1 (
m (4.108)
The integral which appears in (4.106) has been evaluated in Appendix A. We
have, using (A.16) and the notation of this section

t
0
m
0
s s
ds ) C e ( e
] ) C ; 1 ; , m ( F ) e C ; 1 ; , m ( F e [
1
0
t
0
t
+ +

(4.109)
where

+

m
(4.110)
We are now in a position to find the final expression for the function ) t ( K using
(4.106), (4.105) and (4.109):

1
1
0 0
t 1
1
0
t
) C 1 ( K e ) C e ( ) t ( K
60
] ) C ; 1 ; , m ( F ) e C ; 1 ; , m ( F e [
D
0
t
0
t 0
+ +

or

'
'

) t (
D
) C 1 ( K e ) R e ( ) t ( K
0 1
1
0 0
t 1
1
t
(4.111)
where
) C ; 1 ; , m ( F ) e C ; 1 ; , m ( F e ) t (
0
t
0
t
+ +

(4.112)
the human capital. Substituting into (4.12) the expression for u given by (4.80),
we obtain the following differential equation
K N
A ) 1 (
H ) ( H
1
1
H
K
1
,
`
.
|
,
`
.
|

(4.113)

,
`
.
|
,
`
.
|
+ +
,
`
.
|
1
1
0
t
1
1
1
H
K
) C e ( t exp
n
Using the previous expression and also (4.15) for N, we get the following
differential equation for H:
K ) C e ( e Q H ) ( H
1
1
0
t t

(4.114)
where
,
`
.
|
+ +
,
`
.
|

1
0
1
1 1
N
n A ) 1 (
Q (4.115)
and

+

n ) 1 (
(4.116)
61
Using now the expression for ) t ( K given by (4.111), we obtain the equation
+ H ) ( H
,
`
.
|

) t (
D
) C 1 ( K ) C e ( e Q
0 1
1
0 0
1
1
0
t t ) (
(4.117)
This is a linear first order differential equation with integration factor

t ) (
e


,
`
.
|
+
) t (
D
) C 1 ( K e Q ) H e (
dt
d
0 1
1
0 0
t ) ( t ) (
(4.118)

,
`
.
|

t
0
0 1
1
0 0
t
0
t ) (
dt ) t (
D
) C 1 ( K e Q H ) t ( H e (4.119)
where
+ (4.120)
The integral in the previous equation can be written as
,
`
.
|
t
0
0 1
1
0 0
t
dt ) t (
D
) C 1 ( K e ) t ( X
+
,
`
.
|
+

t
0
t
0
0 1
1
0 0
dt e ) C ; 1 ; , m ( F
D
) C 1 ( K

+

+
t
0
t
0
t 0
dt ) e C ; 1 ; , m ( F e
D
(4.121)
where
(4.122)
62
from the theory of Generalized Hypergeometric Functions. We have evaluated this
integral in Appendix B. We have, using (B.11) and the notation of this section
+

t
0
t
0
t
dt ) e C ; 1 ; , m ( F e

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
C
1 , 1 p
, m , p
F e C
1 , 1 p
, m , p
F e
p
1
(4.123)
where

p (4.124)
,
`
.
|
t
0
0 1
1
0 0
t
dt ) t (
D
) C 1 ( K e ) t ( X
,
`
.
|
,
`
.
|
+

1 e
) C ; 1 ; , m ( F
D
) C 1 ( K
t
0
0 1
1
0 0
'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
2
C
1 , 1 p
, m , p
F e C
1 , 1 p
, m , p
F e
p
1
(4.125)
From (4.119) we arrive at the following final expression for the function ) t ( H :
t ) (
0
e )} t ( X Q H { ) t ( H

(4.126)
where ) t ( X is given by (4.125).
5. Application II.
(A more complicated Lucas-Uzawa model with externalities).
In this section we find a closed-form solution of the model considered by
Bucekkine and Ruiz-Tamarit (solved in Section 4) with externalities.
63
5.0. The model.

t
0
1
e ) t ( N
1
1 ) t ( C
max

(5.1)
subject to
) t ( N ) t ( C ) t ( K ) t ( H )) t ( H ) t ( N ) t ( u ( ) t ( K A ) t ( K
1

(5.2)
) t ( H ) t ( H )) t ( u 1 ( ) t ( H (5.3)

0
K ) 0 ( K ,
0
H ) 0 ( H ,
0
N ) 0 ( N (5.4)
where
0 ) t ( C , ] 1 , 0 [ ) t ( u , 0 ) t ( K , 0 ) t ( H (5.5)
This is the model considered in previous section augmented with externalities.
+

) t ( N
1
1 ) t ( C
) K , N , H , u , C ( H
1
c
+ +

] ) t ( N ) t ( C ) t ( K ) t ( H )) t ( H ) t ( N ) t ( u ( ) t ( K A [
1
K
] ) t ( H ) t ( H )) t ( u 1 ( [
H
+ (5.6)
where
K
and
H
respectively.
0 N N C 0
C
H
K
c

(5.7)
64
0 ) H ( ] H ) H N ( u K A ) 1 ( [ 0
u
H
H
1
K
c
+

(5.8)
+
K K
c
K
H

+ H ) H N u ( K A ) (
1 1
K K K
(5.9)
+
H H
c
H
H
+ +

H ) N u ( K A ) 1 ( ) (
1
K H H

) u 1 (
H
(5.10)
N C K H ) H N u ( K A K
1

,
0
K ) 0 ( K (5.11)
H H ) u 1 ( H ,
0
H ) 0 ( H (5.12)
0 e K lim
t
K
t

(5.13)
0 e H lim
t
H
t

(5.14)
We also suppose that we have the exponential (exogenous) population growth
given by

t n
0
e N ) t ( N (5.15)
5.2. First method of solution to the model.
equation (5.7) that
65

K
K
C
C

(5.16)
equation (5.8) that

H
H
K
K
H
H
) (
N
N
) 1 (
u
u
K
K
+ + +

(5.17)

+
H ) H N u ( AK
1 1
K
K
(5.18)

H
K 1
H
H
H ) N u ( AK ) 1 ( ) u 1 (
+ +

(5.19)

K
N C
H ) H N u ( AK
K
K
1 1
(5.20)
) u 1 (
H
H
(5.21)
n
N
N
(5.22)

H ) H N u ( AK Y
1
(5.23)

K
Y
K
K
+
(5.24)

H
Y
) 1 ( ) u 1 (
H
K
H
H
+ +
(5.25)
66

K
N C
K
Y
K
K
(5.26)
u
1 H
Y
H
K

(5.27)
u
1
H
H
(5.28)

K
Y
C
C
(5.29)
Equation (5.17), upon substituting the expressions given by (5.24), (5.26), (5.22)
and (5.28), we obtain the equation

K
C N
u
1
) 1 (
u
u

+
+ (5.30)
where
+
+ + +

) ( n ) 1 (
(5.31)

K
Y
U (5.32)
and

K
C N
Z (5.33)
respectively.
67

K
K
Y
Y
U
U

(5.34)
and

K
K
C
C
N
N
Z
Z

+ (5.35)
respectively.
Z U
K
K
(5.36)

U
C
C
(5.37)
Y
Y

H
H
) 1 (
N
N
) 1 (
u
u
) 1 (
K
K
Y
Y

+ + + + (5.38)
K
K
,
u
u
and
H
H
given by (5.26), (5.30), (5.22) and (5.21)
+ Z U
Y
Y
(5.39)
where
) ( ) 1 ( n ) 1 ( ) 1 ( + + + (5.40)
68
U ) 1 (
U
U
+ (5.41)
and

+
+ +

+ n U Z
Z
Z
(5.42)

0
t
t
C e
e
1
1
U
(5.43)
where
+ and
) 0 ( U ) 1 (
1 C
0

+
(5.44)
the equation

2
0
t
t
Z Z n
C e
e
) 1 (
Z
,
`
.
|
+
+ +
(5.45)

1
Z X

(5.46)
1 X n
C e
e
) 1 (
X
0
t
t

,
`
.
|
+
+ +
(5.47)

) C e ( e ) t ( I
0
t t
(5.48)
where

+
+ n and
) 1 (

(5.49)
69

) C e ( e ) X ) t ( I (
dt
d
0
t t
ds ) C e ( e ) 0 ( X ) 0 ( I X ) t ( I
t
0
0
s s

(5.50)
) t (
1
ds ) C e ( e
t
0
0
s s

(5.51)
where
) C ; 1 ; , ( F ) e C ; 1 ; , ( F e ) t (
0
t
0
t
+ +

(5.52)
and

+
(5.53)

) C e ( e
) t (
1
) 0 ( X ) C 1 (
X
0
t t
0
(5.54)

) t (
1
) 0 ( X ) C 1 (
) C e ( e
Z
0
0
t t

(5.55)
Since from (5.51) we have upon differentiation with respect to t, the relation

,
`
.
|

) t (
1
dt
d
) C e ( e
0
t t
(5.56)

W
W
Z

(5.57)
70
where
) t (
1
) 0 ( X ) C 1 ( W
0

+

(5.58)

V
V
1
1
U

(5.59)
where

0
t
C e V

(5.60)
+

W
W
V
V
1
1
K
K

(5.61)

t
1
1
0
e W V D K

or

t
0
1
1
0
t
0
e ) t (
1
) 0 ( X ) C 1 ( ) C e ( D ) t ( K

'
'
+ (5.62)
where

'
'

) 0 (
1
) 0 ( X ) C 1 ( ) C 1 (
K
) 0 ( W ) 0 ( V
K
D
0
1
1
0
0
1
1
0
0
(5.63)

W
W
u
1
) 1 (
u
u

+

+
+
71

2
u
1
) 1 (
u
W
W
u

+
,
`
.
|
+

(5.64)

1
u y

(5.65)

+

,
`
.
|
+ +
1
) 1 (
y
W
W
y

(5.66)
W e ) t ( J
t
(5.67)
W e
1
) 1 (
) y ) t ( J (
dt
d
t

+


+

t
0
t
ds ) s ( W e
1
) 1 (
) 0 ( y ) 0 ( J y ) t ( J (5.68)
Let

t
0
t
ds ) s ( W e ) t ( X (5.69)

t
0
s
ds ) s ( W e ) t ( X
+
'
'

t
0
s
0 0
ds e ) C ; 1 ; , ( F
1
) 0 ( X ) C 1 (
+
t
0
s
0
s ) (
ds ) e C ; 1 ; , ( F e
1
(5.70)
72
+

t
0
t
0
t
dt ) e C ; 1 ; , ( F e

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
1
(5.71)
where
and
p (5.72)

t
0
s
ds ) s ( W e ) t ( X

,
`
.
|
'
'
1 e
) C ; 1 ; , ( F
1
) 0 ( X ) C 1 (
t
0 0
'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
2
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
1
(5.73)

) t ( J
) t ( X ) 0 ( y ) 0 ( J
y

(5.74)
and then

) t ( X ) 0 ( y ) 0 ( J
) t ( J
) t ( u

(5.75)
where we have put

+

1
) 1 (
(5.76)
Equation (5.75) can also be written as (comparing (5.67) and (5.69))
73

) t ( X ) 0 ( y ) 0 ( J
) t ( X
) t ( u

(5.77)
Equation (5.21) for the human capital, because of the previous expression, takes
on the form

) t ( X ) 0 ( y ) 0 ( J
) t ( X
H
H

+

or even

S
S
H
H

+ (5.78)
where
) t ( X ) 0 ( y ) 0 ( J S (5.79)

t 0
e S
) 0 ( S
H
H

or

t 1
1
1
1
0
e ) t ( S
) 0 ( S
H
) t ( H
+

+

(5.80)
5.3. Second method of solution of the model.
From equation (5.7), solving with respect to C, we obtain

1
K
) ( C (5.81)
From equation (5.8), solving with respect to u, we obtain
74

H
K
H N
A ) 1 (
u
1
H
K
1
1
,
`
.
|
,
`
.
|

(5.82)
We also get from the previous relation the two relations

,
`
.
|
,
`
.
|
1
) 1 (
1
H
K
1
1
1
K H N
A ) 1 (
) uNH ( (5.83)
and

,
`
.
|
,
`
.
|
1
) )( 1 (
1
H
K
1
1
1
K H N
A ) 1 (
) uN ( (5.84)

K
1
H
K
1
1
K K
H N
A ) 1 (
A ) (
,
`
.
|
,
`
.
|
(5.85)
+
H H
) (
K H N
A ) 1 (
A
K
1
H
K
1
1
,
`
.
|
,
`
.
|

(5.86)
Equation (5.11), using (5.83) and (5.81), takes the simplified form
+ K K
,
`
.
|
,
`
.
|
1
K
1
H
K
1
1
) ( N K H N
A ) 1 (
A (5.87)
Equation (5.12), because of (5.82) takes the form
75
K H N
A ) 1 (
H ) ( H
1
H
K
1
1
,
`
.
|
,
`
.
|

(5.88)
5.3.5. The solution strategy.
Equations (5.85)-(5.88) constitute a system of four equations which determine
completely the dynamics of the model. The solution strategy we follow is quite
different compared to the one we used without the externalities.
The first observation is that equation (5.86) cannot be solved as it is, since its right
hand side contains unknown quantities. Therefore we have to modify the solution
strategy in the presence of externalities.
Dividing (5.86) by (5.88) we obtain the equation

H 1 H ) ( H
) (
H H H

0
H
H ) ( H
1
) (
H
H H
+

(5.89)
The previous equation can be written as

H
H
1
H
H

(5.90)
where
) (
1
) (

+ + (5.91)
Equation (5.90) admits the solution

t
1
0 H
e ) t ( H C ) t (

(5.92)
where

1
H
0
) 0 ( H
) 0 (
C (5.93)
76
Equation (5.92) expresses a relation between
H
and H. However this relation
simplifies considerably the other equations of motion. We then can obtain closed-
form solutions.
5.3.5.1. Solution of equation for the costate variable
K
.
Using this equation into the equation (5.85) for
K
, we obtain the equation

,
`
.
|
,
`
.
|

+
1
K
1
1
0
K K
) ( t
) 1 (
exp N
C
A ) 1 (
A ) ( (5.94)
which can be solved, since it is a Bernoulli differential equation.
In fact multiplying this equation through by
1
K
) ( , and taking into account
equation (5.15) for the population, we obtain the equation

t
1
1
K
1
K K
e ) ( ) ( ) (

+ (5.95)
where

,
`
.
|

1
0
0
C
AN ) 1 (
A (5.96)
and

) 1 ( ) n (
(5.97)
Introducing a new function by

1
1
K
) ( (5.98)
equation (5.95) takes on the form

t
e
) 1 ( ) ( ) 1 (

+
+ (5.99)
The previous equation admits the function
t
e
as an integrating factor, where

77

+

) ( ) 1 (
(5.100)
Therefore the general solution is given by
C e
) (
) 1 (
e
t ) ( t
+
+

+
(5.101)
For 0 t , we obtain from the previous equation the relation
C
) (
) 1 (
) 0 ( +
+

(5.102)
from which we determine the constant C.
Therefore we obtain from equation (5.101) the following expression for the
function :

t t
e
) (
) 1 (
) 0 ( e
) (
) 1 (

,
`
.
|
+

+
+

The above equation, taking into account (5.98), can be expressed in terms of the
function
K
as
t
1
K
t
1
K
e
) (
) 1 (
) 0 ( e
) (
) 1 (
) (

,
`
.
|
+

+
+

The previous equation can also be written as
t
1
K
e
) (
) 1 (
) (

'
'

+
+ +

+
1
K
t ) (
)) 0 ( (
) 1 (
) (
e 1
or, in equivalent form,

,
`
.
|
+

+ +
t
) ( ) 1 (
exp
n
) (
1
K
78

'
'
+ +
+
,
`
.
|
+ +
+

1
K
)) 0 ( (
n
t
) n ( ) 1 (
exp 1 (5.103)
taking into account the expression for and that
+ +

+
n
1
) (
From equation (5.103) we get the following expression for the costate variable
K
:

t ) (
1
0
t
1
K
e ) D e (
n
+

,
`
.
|
+ +
(5.104)
+ +

) n ( ) 1 (
(5.105)
+ +

1
K 0
)) 0 ( (
n
1 D (5.106)
Equation (5.104) is an explicit expression for the costate variable
K
.
5.3.5.2. Solution of equation for the physical capital.
We now consider equation (5.87). This equation, because of (5.92), takes the form
+ K K

,
`
.
|
,
`
.
|
1
K
1
K
1
1
0
) ( N K t
) 1 (
exp ) ( N
C
A ) 1 (
A (5.107)
Using the expressions (5.104) for
K
and (5.15) for the population, we get from
the previous equation
+ K K

,
`
.
|
+ +
,
`
.
|

) D e (
n
C
A ) 1 (
A
0
t
1
0
79

'
'
,
`
.
|
+
+

K t
) 1 ( ) 1 ( ) ( ) 1 ( n
exp

'
'
,
`
.
|
,
`
.
|
+ +
t n exp ) D e (
n
N
) 1 (
0
t
) 1 (
0
(5.108)
The previous equation can be simplified considerably. Using (5.96) in place of
we find

+ +
,
`
.
|
+ +
,
`
.
|

1
n n
C
A ) 1 (
A
1
0
(5.109)
where we also have used expression (5.105) for .
We also have that
t
e t
) 1 ( ) 1 ( ) ( ) 1 ( n
exp

'
'
,
`
.
|
+
+

(5.110)
using (5.105) again.
Therefore (5.108) takes on the form

,
`
.
|
K
D e
e
1
1
K
0
t
t
'
'
,
`
.
|
,
`
.
|
+ +
t n exp ) D e (
n
N
) 1 (
0
t
) 1 (
0
(5.111)
The above differential equation is a linear first order differential equation with
integrating factor

'
'
,
`
.
|

1
1
0
t t
0
t
t
) D e ( e dt
D e
e
1
1
exp ) t ( I (5.112)
Therefore multiplying (5.111) by the integrating factor, we obtain the equation
)) t ( I ) t ( K (
dt
d
80
'
'
,
`
.
|
+
+
,
`
.
|
+ +
t n exp ) D e (
n
N
1
1
) 1 (
0
t
) 1 (
0

t
0
0
t t
0 0
ds ) D e ( e F ) 0 ( I K ) t ( I ) t ( K (5.113)
where

) 1 (
0 0
n
N F

,
`
.
|
+ +
(5.114)

+
+ n (5.115)

1
1
) 1 (
(5.116)
The integral appearing in the right-hand-side of (5.113) has been evaluated in
Appendix A. We have, using the notation of this section:
) t (
1
ds ) D e ( e
t
0
0
s s

(5.117)
where

+
(5.118)
and
) D ; 1 ; , ( F ) e D ; 1 ; , ( F e ) t (
0
t
0
t
+ +

(5.119)
We thus get the following expression for the physical capital K:

'
'

+
1
1
0
t 0
1
1
0 0
) D e ( ) t (
F
) D 1 ( K ) t ( K (5.120)
5.3.5.3. Solution of equation for the human capital
81
the human capital. Substituting into (5.88) the expression (5.92) for
H
, we obtain
the following differential equation

,
`
.
|
,
`
.
|
t exp K H ) ( N
C
A ) 1 (
H ) ( H
1
1
K
1
1
0
(5.121)
Using the expressions for K and
K
given by (5.120) and (5.104) respectively,
and also the equation (5.15) for the human capital, the previous equation becomes

'
'

+ +

1
0
1
1
0 0 0
H ) t ( F
~ F
) D 1 ( K G H ) ( H

'
'
,
`
.
|
+
+

t
) 1 ( n
exp (5.122)
where

,
`
.
|
+ +
,
`
.
|

1
1
1
0
1
0
0
n
N
C
A ) 1 (
G (5.123)
Equation (5.122) is a Bernoulli differential equation. Multiplying this equation
through by

1
H , we obtain the equation
'
'

+ +

) t (
F
) D 1 ( K G H ) ( H H
0
1
1
0 0 0
1
1
1

'
'
,
`
.
|
+
+

t
) 1 ( n
exp (5.124)
Introducing a new function U by

1
1
H U , the above equation is converted to
the linear first order differential equation
82

'
'

+

+

+
+

) t (
F
) D 1 ( K G
1
) 1 (
U
1
) )( 1 (
U
0
1
1
0 0 0

'
'
,
`
.
|
+
+

t
) 1 ( n
exp (5.125)
Multiplying the above equation by the integrating factor

,
`
.
|

+
t
1
) )( 1 (
exp ) t ( J (5.126)
becomes equivalent to
t 0
1
1
0 0 0
e ) t (
F
) D 1 ( K G
1
) 1 (
) U ) t ( J (
dt
d

'
'

+

+
(5.127)
where

+
+

+

+

) 1 ( n
1
) )( 1 (
(5.128)
Integrating equation (5.127) in the interval ] t , 0 [ , we obtain

,
`
.
|

+

+

t
0
0
1
1
0 0
t
0
dt ) t (
F
) D 1 ( K e G
1
1
) 0 ( U U ) t ( J (5.129)
The integral in the previous equation can be written as
,
`
.
|
t
0
0
1
1
0 0
t
dt ) t (
F
) D 1 ( K e ) t ( X
+
,
`
.
|
+

t
0
t
0
0
1
1
0 0
dt e ) D ; 1 ; , ( F
F
) D 1 ( K

+

+
t
0
t
0
t ) ( 0
dt ) e D ; 1 ; , ( F e
F
(5.130)
83
from the theory of Generalized Hypergeometric Functions. We have, using
Appendix B
+

t
0
t
0
t a
dt ) e D ; 1 ; , ( F e

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t a
D
1 , 1 p
, , p
F e D
1 , 1 p
, , p
F e
p
1
(5.131)
where
a and

a
p (5.132)
,
`
.
|

+
t
0
0
1
1
0 0
t
dt ) t ( F
~ F
) D 1 ( K e ) t ( X

,
`
.
|
,
`
.
|
+

1 e
) D ; 1 ; , ( F
F
) D 1 ( K
t
0
0
1
1
0 0

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t a
2
0
D
1 , 1 p
, , p
F e D
1 , 1 p
, , p
F e
p
F
(5.133)
From (5.129) we arrive at the following expression for the function U:
,
`
.
|

+

,
`
.
|

+
t
1
) )( 1 (
exp ) t ( X G
1
1
) 0 ( U U
0
(5.134)
where ) t ( X is given by (5.133).
Using the fact that

1
1
H U , we find the following expression for the human
capital H:

t ) (
1
1
0
1
1
0
e ) t ( X G
1
1
) H ( ) t ( H

+

+
,
`
.
|

+
(5.135)
84
6. Application III.
(The model considered by Ruiz-Tamarit and Snchez-Moreno)
We now find the closed-form solution of the model introduced by Ruiz-Tamarit
and Snchez-Moreno [29] on optimal regulation in a natural resource based
economy.
6.0. The Model.
dt e N
1
1 ) t ( C
max
t
0
1

(6.1)
subject to
) t ( C N )) t ( Q ) t ( u ( ) t ( AK ) t ( K
1

(6.2)
) t ( Q ) t ( u ) t ( Q )) t ( u 1 ( ) t ( Q (6.3)
0 K ) 0 ( K
0
> , 0 Q ) 0 ( Q
0
> (6.4)
where
0 ) t ( C , ] 1 , 0 [ ) t ( u , 0 ) t ( K , 0 ) t ( Q (6.5)
In this model ) t ( Q is a renewable natural resource and ) t ( u is the aggregate
extraction rate, while N is the population (considered constant).
) K , H , u , C ( H
c
+ +

] ) t ( NC )) t ( H ) t ( u ( ) t ( K A [ N
1
1 ) t ( C
1
K
1
] ) t ( Q )) t ( u ) 1 ( ( [
Q
+ + (6.6)
85
where
K
and
Q
are the costate variables corresponding to K and Q
respectively.
0 C 0
C
H
K
c

(6.7)
0 ] ) Q u ( AK ) 1 ( [ ) 1 ( 0
u
H
K Q
c
+ +

(6.8)

+
1 1
K K K K K
c
) Q u ( AK
K
H
(6.9)
+
Q Q
c
Q
H

) u ) 1 ( ( Q ) Q u ( K ) 1 (
Q
1 1
K Q Q
+

(6.10)
) t ( C N )) t ( Q ) t ( u ( ) t ( AK ) t ( K
1

,
0
K ) 0 ( K (6.11)
) t ( Q ) t ( u ) t ( Q )) t ( u 1 ( ) t ( Q ,
0
Q ) 0 ( Q (6.12)
0 e K lim
t
K
t

(6.13)
0 e Q lim
t
Q
t

(6.14)
6.2. The method of solution.
86

1
K
) ( C (6.15)

Q
K
1
A ) 1 (
u
1
Q
K
1
,
`
.
|
,
`
.
|
+

(6.16)

,
`
.
|
,
`
.
|
+

1
1
Q
K
1
1
K
1
A ) 1 (
) Q u ( (6.17)
0 ) (
Q Q
+ (6.18)

t ) (
Q Q
e ) 0 (

(6.19)

K
1
Q
K
1
K K
1
A ) 1 (
A
,
`
.
|
,
`
.
|
+

(6.20)
This equation can be written as (because of (6.19))

,
`
.
|
,
`
.
|

+

1
K
1 1
Q K K
) ( t
) )( 1 (
exp ) 0 (
A ) 1 (
1
A
is a Bernoulli differential equation. Multiplying this equation through by
1
K
) ( ,
we derive the equation

1
1
K
1
K K
) ( ) (
87

,
`
.
|
,
`
.
|

+

1 1
Q
t
) )( 1 (
exp ) 0 (
A ) 1 (
1
A (6.21)
Introducing the function by

1
1
K
) ( (6.22)
equation (6.21) is converted to the equation

+
) 1 (
,
`
.
|
,
`
.
|
+

+

t
) )( 1 (
exp )) 0 ( (
1
A ) 1 (
) 1 (
1
Q
1
(6.23)
which is a linear first order differential equation.
Since the integrating factor is

,
`
.
|

t
) 1 (
exp ) t ( I
equation (6.23) can be written by multiplying through by ) t ( I

,
`
.
|
,
`
.
|
+

+

t
) 1 (
exp )) 0 ( (
1
A ) 1 (
) 1 ( ) ) t ( I (
dt
d
1
Q
1
and by integration in the interval ] t , 0 [ ,
ds s
) 1 (
exp )) 0 ( (
1
A ) 1 (
) 1 ( ) 0 ( ) 0 ( I ) t ( I
t
0
1
Q
1

,
`
.
|
,
`
.
|
+

+

or

,
`
.
|
'
'
]
]
]
,
`
.
|
t
) 1 (
exp 1 t
) 1 (
exp )) 0 ( ( ) 0 (
1
Q
(6.24)
where
88

,
`
.
|
+

+

1
1
A ) 1 (
) 1 (
) 1 (
(6.25)
Equation (6.24), written in terms of
K
, is given by
'
'
]
]
]
,
`
.
|
1 t
) 1 (
exp )) 0 ( ( )) 0 ( ( ) (
1
Q
1
K
1
K
,
`
.
|

t
) 1 (
exp
or
,
`
.
|
t
) 1 (
exp ) C e ( )) 0 ( ( ) (
0
t
1
Q
1
K
(6.26)
where

) 1 (
(6.27)
and

,
`
.
|

1
Q
K
0
) 0 (
) 0 ( 1
1 C (6.28)
We thus derive from (6.26) the following expression for the costate variable
K
:

t 1
0
t
Q
1
K
e ) C e ( ) 0 (

(6.29)
takes the form

,
`
.
|
,
`
.
|

+
1
K
1
Q
K
1
) ( N K
A ) 1 (
1
A K (6.30)
89
In order to simplify the above expression, we need to find the ratio of the costate
variables. Using the expressions (6.29) and (6.19), we obtain

0
t
t
1
1
Q
K
C e
e
,
`
.
|

(6.31)
Equation (6.30), taking into account (6.31) and (6.29), takes on the form

,
`
.
|

+
K
C e
e
A ) 1 (
1
A K
0
t
t
1
1
,
`
.
|
t exp ) C e ( )) 0 ( ( N
) 1 (
0
t
1
Q
) 1 (
(6.32)
The previous equation can be simplified considerably using the definition of
parameters introduced earlier.
We find, using the definition (6.25) of and (6.27) of :

,
`
.
|

+

1 A ) 1 (
1
A
1
1
Therefore (6.32) takes the form

,
`
.
|
t exp ) C e ( D K
C e
e
1
1
K
) 1 (
0
t
0
0
t
t
(6.33)
where

1
Q
) 1 (
0
)) 0 ( ( N D (6.34)
Equation (6.33), which is a linear first order differential equation, admits the
integrating factor

,
`
.
|

1
1
0
t
0
t
t
) C e ( dt
C e
e
1
1
exp ) t ( J (6.35)
Multiplying equation (6.33) through by the integrating factor ) t ( I , we find
90

,
`
.
|
t exp ) C e ( D )) t ( J ) t ( K (
dt
d
1
1
) 1 (
0
t
0

t
0
0
s s
0 0
ds ) C e ( e D ) 0 ( J K ) t ( J ) t ( K (6.36)

1
1
) 1 (
and
(6.37)
The integral appearing in (6.36) is not elementary. It can be evaluated using the
hypergeometric function, known from the theory of differential equations in the
complex domain. All the relevant calculations appear in Appendix A. We have
found using (A.16) and the notation of this section

t
0
0
s s
ds ) C e ( e
] ) C ; 1 ; , ( F ) e C ; 1 ; , ( F e [
1
0
t
0
t
+ +

(6.38)
where

+
(6.39)
We are now in a position to write down the final expression for the function ) t ( K

,
`
.
|

+
1
1
0
t 0 1
1
0 0
) C e ( ) t (
D
) C 1 ( K ) t ( K (6.40)
where
) C ; 1 ; , ( F ) e C ; 1 ; , ( F e ) t (
0
t
0
t
+ +

(6.41)
6.2.4. Equation for the renewable natural resource Q.
91
the renewable natural resource Q. Substituting into (6.12) the expression for u
given by (6.16), we obtain the following differential equation
K
A ) 1 (
1
) 1 ( Q Q
1
Q
K
1
,
`
.
|
,
`
.
|

+
+ (6.42)

,
`
.
|
,
`
.
|
1
1
0
t
t
1
1
1
Q
K
C e
e
Using the above expression and also (6.40) in (6.42), we obtain the equation
,
`
.
|

,
`
.
|
t
1
exp ) t (
D
) C 1 ( K E Q Q
0 1
1
0 0 0
(6.43)
where

,
`
.
|

+
+
1
1
1
0
A ) 1 (
1
) 1 ( E (6.44)
Equation (6.43) is a linear first order differential equation with integration factor

t
e ) t ( I


'
'
,
`
.
|

,
`
.
|

t
1
exp ) t (
D
) C 1 ( K E ) Q e (
dt
d
0 1
1
0 0 0
t
(6.45)

,
`
.
|

t
0
0 1
1
0 0
t
0 0
t
dt ) t (
D
) C 1 ( K e E Q Q e (6.46)
92
Using the expression for the function ) t ( , given in (6.41), equation (6.46) can be
transformed into the equation

0
t
Q Q e
+
'
,
`
.
|
+
t
0
t
0
0 1
1
0 0 0
dt e ) C ; 1 ; , ( F
D
) C 1 ( K E
'
+

t
0
t
0
t ) 1 ( 0
dt ) e C ; 1 ; , ( F e
D
(6.47)
from the theory of Generalized Hypergeometric Functions. We put the integral
into the form

+
t
0
t
0
t
dt ) e C ; 1 ; , ( F e (6.48)
where
) 1 ( (6.49)
The integral has been evaluated in Appendix B. Using (B.11) and the notation of
this section, we have
+

t
0
t
0
t
dt ) e C ; 1 ; , ( F e

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
1
(6.50)
where the parameter p has defined by: p .
Therefore from (6.47), using (6.50), we arrive at the following final expression for
the function ) t ( Q :
)] t ( X E Q [ e ) t ( Q
0 0
t

(6.51)
where ) t ( X is given by
93
,
`
.
|
t
0
0 1
1
0 0
t
dt ) t (
D
) C 1 ( K e ) t ( X
+
,
`
.
|
+
t
0
t
0
0 1
1
0 0
dt e ) C ; 1 ; , ( F
D
) C 1 ( K
+
+

t
0
t
0
t ) 1 ( 0
dt ) e C ; 1 ; , ( F e
D

,
`
.
|
,
`
.
|
+
1 e
) C ; 1 ; , ( F
D
) C 1 ( K
t
0
0 1
1
0 0

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
2
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
A
(6.52)
6.2.5. Expressions for the control variables.
It is now easy to find the expressions of the control variables ) t ( u and ) t ( C
using the functions we have already calculated.
The control variable ) t ( C is given by (6.15). Substituting into this expression the
K
given by (6.29), we obtain

,
`
.
|
t exp ) C e ( )) 0 ( ( ) t ( C
) 1 (
0
t
1
Q
) 1 (
(6.53)
Using (6.16) for the control variable ) t ( u (the aggregate extraction rate), we first
find the ratio
H
K
from (6.31) and then substitute the expressions for K and Q

from (6.40) and (6.51) respectively. We obtain
94

'
'
,
`
.
|

+
,
`
.
|
+

t
1
exp
1
A ) 1 (
) t ( u
1
1

) C e (
) t ( X E Q
) t (
D
) C 1 ( K
0
t
0 0
0 1
1
0 0

(6.54)
where all the functions and parameters are defined in the text.
7. Application IV. Optimal Fiscal Policy.
In this section we examine the issue of optimal fiscal policy, along the lines of the
paper by Gmez [11].
7.1. The model for the decentralized economy.
dt e
1
1 ) t ( C
max
t
0
1

(7.1)
subject to
H ) u 1 ( H , 0 > (7.2)
and
H w s C H u w ) 1 ( K r ) 1 ( K
h h k
+ + (7.3)
Equation (7.2) is the human capital evolution equation and (7.3) is the
corresponding evolution equation for the physical capital (the household budget
constraint).
In (7.3) we denote by r the rate of return on physical capital, and w the wage
rate. They are given by

K
Y
r and
H u
Y
) 1 ( w (7.4)
95
The variable
k
is the rate government taxes the physical capital, and
h
is the
rate government taxes the labor income, while
h
s is the rate government
subsidizes investment in education.

h h h
s + (7.5)
equation (7.3) can be written as
H w s C H u w ) 1 ( K r ) 1 ( K
h h k
+ + (7.6)
We further assume that the government runs a balanced-budget and has no access
to lump-sum taxation, which means that H ) u 1 ( w s H u w K r
h h k
+ , or using
equation (7.5),
H w s H u w K r
h h k
+ (7.7)
The production function is given by

a
1
H ) H u ( K A Y , 0 A > , 1 0 < < , 0 > (7.8)
where
a
H is the measure of the externality. In equilibrium condition we have
H H
a
.
7.1.1. The dynamical equations.
The current value Hamiltonian of the optimization problem is given by
) K , H , u , C ( H
c
+ + + +

] H w s C H u w ) 1 ( K r ) 1 ( [
1
1 C
h h k K
1
] H ) u 1 ( [
H
+ (7.9)
where
K
and
H
respectively.
96
0 C 0
C
H
K
c

(7.10)
0 H ] H w ) 1 ( [ 0
u
H
H h K
c

(7.11)
K K K k K K
c
r ) 1 (
K
H
+ +
(7.12)
+
H H
c
H
H

H H H h h K
) u 1 ( ] w s u w ) 1 ( [ + + +

(7.13)
H w s C H u w ) 1 ( K r ) 1 ( K
h h k
+ + ,
0
K ) 0 ( K (7.14)
H ) u 1 ( H ,
0
H ) 0 ( H (7.15)
the governments budget constraint
H w s H u w K r
h h k
+ (7.16)
0 e K lim
t
K
t

(7.17)
0 e H lim
t
H
t

(7.18)
7.1.2. Transformation of the equations.
From equation (7.10), taking logarithms and differentiation with respect to time,
we find

K
K
C
C

(7.19)
From (7.12) we obtain the equation
97
r ) 1 (
k
K
K

and using the expression for r (the first equation in (7.4)) we find

K
Y
) 1 (
k
K
K

(7.20)
where Y is given by (7.8) in equilibrium ( H H
a
).
After combining (7.19) with (7.20), we get the following expression

K
Y ) 1 (
C
C
k
(7.21)
From equation (7.14), taking into account (7.16) and the expressions (7.4) for r
and w, we obtain the equation

K
C
K
Y
K
K
(7.22)
) u 1 (
H
H
(7.23)
From equation (7.11) we can obtain the following expression for the ratio of the
costate variables

w ) 1 (
h H
K

(7.24)
From equation (7.13) we obtain the equation

H
K
h h
H
H
] w s u w ) 1 ( [ ) u 1 (
which, because of (7.24), takes on the form

,
`
.
|

+
h
h
H
H
1
s
1 (7.25)
We now come again in (7.11). Using the expression for w, we obtain the
following equation
98

H K h
H u K A ) 1 ( ) 1 (

(7.26)
where we also have used the expression for the production function given by (7.8)
in equilibrium. Taking logarithms and differentiating with respect to time equation
(7.26), we arrive at the equation

H
H
K
K
h
h
H
H
) (
u
u
K
K
1
+ +

(7.27)
In the previous equation we substitute the ratios
K
K
,
K
K
,
H
H
and
H
H
given by
(7.20), (7.22), (7.23) and (7.25) respectively, and we obtain the equation

) 1 (
s
) 1 (
u
) ( ) 1 (
K
C
K
Y
u
u
h
h
h
h
k

+
+

(7.28)
The system of equations (7.21), (7.22), (7.23) and (7.28) determine the dynamics
of the decentralized economy.
Introducing a new function Z by

K
C
Z (7.29)
we get

K
K
C
C
Z
Z

(7.30)
Upon substituting the ratios
C
C
and
K
K
given by (7.21) and (7.22) respectively
into (7.30), we derive the equation

,
`
.
|
K
C
K
Y
1
) 1 (
Z
Z
k
(7.31)
7.2. The centrally-planned economy.
99
dt e
1
1 ) t ( C
max
t
0
1

(7.32)
subject to
) t ( C ) t ( H )) t ( H ) t ( u ( ) t ( K A ) t ( K
1

(7.33)
) t ( H )) t ( u 1 ( ) t ( H (7.34)

0
K ) 0 ( K ,
0
H ) 0 ( H (7.35)
where
0 ) t ( C , ] 1 , 0 [ ) t ( u , 0 ) t ( K , 0 ) t ( H (7.36)
7.2.1. The dynamical equations.
) K , H , u , C ( H
c
+ +

] ) t ( C ) t ( H )) t ( H ) t ( u ( ) t ( K A [
1
1 ) t ( C
1
K
1
] ) t ( H )) t ( u 1 ( [
H
+ (7.37)
where
K
and
H
respectively.
0 C 0
C
H
K
c

(7.38)
0 H ] H ) H u ( K A ) 1 ( [ 0
u
H
H
1
K
c

+
(7.39)
100
K K
1 1
K K K
c
H ) H u ( AK
K
H
+ +

(7.40)
+
H H
c
H
H

H H H
1 1
K
) u 1 ( H ) H u ( K A ) 1 ( + + +

(7.41)
C H ) H u ( K A K
1

,
0
K ) 0 ( K (7.42)
H ) u 1 ( H ,
0
H ) 0 ( H (7.43)
and the usual transversality conditions.
The system of equations (7.38)-(7.43) has been solved in Section 3.
We also have from (3.38)
K
C
K
Y
Z
Z
(7.44)
and from (3.28)

K
C
u
1
) 1 ( ) 1 (
u
u

+
+
+
(7.45)
where u has been evaluated, its explicit expression being given by (3.71).
7.3. The optimal fiscal policy.
The question we now pose is what fiscal policy makes the decentralized economy
replicate the first-best optimum attainable by a central planner.
The first observation is that comparing (7.31) to (7.44) we see that the two
expressions coincide if 0
k
, which means that physical capital income should
not be taxed.
Comparing then (7.28) to (7.45), after putting 0
k
, we get
u
1
) 1 (
) 1 (
s
) 1 (
u
) (
h
h
h
h

+

101
from which we derive the expression for
h
s :

h h
h
u
) 1 (
) 1 (
s
(7.46)
(i) Suppose that 0 s
h
. If
h
were constant, equation (7.28) would become
u
) ( ) 1 (
K
C
u
u
+
+ (7.47)
which is different to its corresponding equation (7.44) in a centrally planned
economy. Therefore 0
h
, for each optimal path. But then, we get from (7.46)
the equation
u
) 1 (
) 1 (
h
h

(7.48)
which is not feasible, since when the economy reaches the steady state
) 1 , 0 ( * u u , the governments share will grow indefinitely.
(ii) Since 0
h
in the steady state, the optimal tax should be constant. We thus
have from equation (7.46) that
u
) 1 (
) 1 (
s
h
h

(7.49)
Solving the system of equations (7.49) and (7.7), taking into account 0
k
, we
obtain the expression

+
h
(7.50)
which is the (constant) optimal tax rate on human capital income.
Substituting the expression (7.50) into (7.49), we derive the optimal subsidy rate
h
s :
u
1
s
h
+
(7.51)
The government size, measured as the subsidy (or taxes) share of output is
constant in time, since it is given by
102

+

1
) 1 (
Y
wH s
h
(7.52)
Using equations (7.50) and (7.51) we are able to calculate the tax rate
h
on labor
income calculated to be
) u 1 (
1
s
h h h

+
(7.53)
The government size can be calculated to be
) u 1 (
1
) 1 (
Y
H ) u 1 ( w s
h
(7.54)
which is a time-varying quantity.
The fiscal policy reasoning is along the lines introduced by Gmez [11]. Our
difference however lies to the fact that the time-varying quantities enter through
the control variable u, calculated explicitly in Section 3.2 and given explicitly by
equation (3.71), written down here for convenience

) t ( X ) 0 ( y ) 0 ( J
) t ( J
) t ( u

(7.55)
The various functions appearing in the previous formula have been defined or
calculated in Section 3.2.
We thus arrive at the following Proposition (Gmez [11], Proposition 2):
Proposition. The decentralized economy can attain the first-best equilibrium
solution if physical capital income is not taxed and investment in human capital is
subsidized at a rate
) t ( u
1
) t ( s
h
+
The subsidy can be financed by taxing human capital income at a rate

)) t ( u 1 (
1
) t (
h

+

103
Lump-sum taxation is not required to balance the government budget either in the
steady state or in the transitional phase. The quantity ) t ( u which appears in the
two previous expressions is calculated explicitly and is given by (7.55), where the
various functions and parameters are defined in Section
Appendix A. Evaluation of the integral

t
0
0
s s
ds ) C e ( e (A.1)
In this Appendix we shall evaluate the integral (A.1) using a two-step procedure.
In the first step we shall convert the integral into a combination of integrals each
one having limits 0 and 1.
Using the simple identity
+
) e C 1 ( e ) C e ( e
s
0
s ) (
0
s s
(A.2)
the integral (A.1) becomes

t
0
s
0
s ) (
ds ) e C 1 ( e (A.3)
We make use of the substitution

s
e u

(A.4)
Under this substitution, we get

u
du 1
ds
and
+
u e
s ) (
where
+
(A.5)
Taking into account that the new limits of the integral are

'

t
e u t s
1 u 0 s
the integral in (A.3) takes on the form
104

t
e
1
0
1
du ) u C 1 ( u
1
(A.6)
The above expression can be written as

'
'

1
0
0
1
e
0
0
1
du ) u C 1 ( u du ) u C 1 ( u
1
t
(A.7)
The first integral in the above expression can be converted into an integral with
new limits 0 and 1. This is done using the substitution:
x e u
t
(A.8)
In fact, since

'

1 x e u
0 x 0 u
t
we get

1
0
t
0
1 t
e
0
0
1
dx ) x e C 1 ( x e du ) u C 1 ( u
t
(A.9)
Therefore the expression (A.7) takes the form

'
'

1
0
0
1
1
0
t
0
1 t
du ) u C 1 ( u dx ) x e C 1 ( x e
1
(A.10)
In the second step, we shall express each one of the integrals in terms of the
hypergeometric function ) z ; c ; b , a ( F . This is done using the integral
representation of the hypergeometric function, known from the theory of
differential equations in the complex domain, Ince [15], Morse and Feshbach [22],
Smirnov [32], Whittaker and Watson [35]. It is known that the hypergeometric
function admits the following integral representation (see any of the previously
noted books or any standard monograph on special functions, like Abramowitz
and Stegun [1], Andrews, Askey and Roy [4], Lebedev [16], Rainville [25], or
Slater [31])
105
dt ) t z 1 ( ) t 1 ( t
) b c ( ) b (
) c (
) z ; c ; b , a ( F
1
0
a 1 b c 1 b
(A.11)
when 0 ) b Re( ) c Re( > > .
When 0 1 b c , i.e. b 1 c + , the above integral representation can be written
as
dt ) t z 1 ( t
) 1 ( ) b (
) b 1 (
) z ; b 1 ; b , a ( F
1
0
a 1 b

+
+ (A.12)
and since ) b ( b ) b 1 ( + and 1 ) 1 ( , we have
dt ) t z 1 ( t b ) z ; b 1 ; b , a ( F
1
0
a 1 b

+ (A.13)
The above formula is going to be used for expressing (A.10) in terms of the
hypergeometric function. We find, because of (A.13)
) e C ; 1 ; , ( F
1
dx ) x e C 1 ( x
t
0
1
0
t
0
1
+
(A.14)
and
) C ; 1 ; , ( F
1
dx ) x C 1 ( x
0
1
0
0
1
+

(A.15)
Therefore

t
0
0
s s
ds ) C e ( e
] ) C ; 1 ; , ( F ) e C ; 1 ; , ( F e [
1
0
t
0
t
+ +

(A.16)
where is given by (A.5).
Note. Formula (A.16) is valid within a range of the parameters involved. The
series expansion of the hypergeometric function ) z ; c ; b , a ( F is given by
106

n
1 n n
n n
z
! n ) c (
) b ( ) a (
1 ) z ; c ; b , a ( F

+
where
) 1 n ( ) 1 ( ) (
n
+ + , 1 n
1 ) (
0

is the usual Pochhammer symbol.
The above series converges for 1 | z | < . For different values of z, an analytic
continuation needs to be considered.
Appendix B. Evaluation of the integral

+
t
0
t
0
t
dt ) e C ; 1 ; , ( F e (B.1)
We shall evaluate this integral in two steps:
In the first step we shall convert the above integral into a combination of integrals
having each one of them limits 0 and 1.
Under the transformation

s
e u

,
u
du 1
ds
and
u e
s
(B.2)
and taking into account that the new limits are

'

t
e u t s
1 u 0 s
the integral in (B.1) transforms into

,
`
.
|
t
e
1
0
u
du
) u C ; 1 ; , ( F u
1
which can also be written as
'
'
+ +
,
`
.
|

1
0
0
1 p
e
0
0
1 p
du ) u C ; 1 ; , ( F u du ) u C ; 1 ; , ( F u
1
t
(B.3)
107
where

p (B.4)
Using the substitution
x e u
t
(B.5)
we get
+
t
e
0
0
1 p
du ) u C ; 1 ; , ( F u

+
1
0
t
0
1 p t p
dx ) x e C ; 1 ; , ( F x e (B.6)
Collecting the above, we have
+

t
0
t
0
t
dt ) e C ; 1 ; , ( F e
+ +

1
0
t
0
1 p t p
dx ) x e C ; 1 ; , ( F x e
1
+

1
0
0
1 p
du ) u C ; 1 ; , ( F u
1
(B.7)
In the second step we shall express each one of the integrals appearing in (B.7) in
terms of the generalized hypergeometric function ] [ F
2 3
.
We have the following general formula (see for example Rainville [25], Section
49, Theorem 28):
]
]
]
dt t z
b , , b
a , , a
F ) t 1 ( t
) a b ( ) a (
) b (
q 2
p 2
1 q 1 p
1
0
1 a b 1 a
1 1 1
1
1 1 1
]
]
]
z
b , , b , b
a , , a , a
F
q 2 1
p 2 1
q p
(B.8)
From the above formula we obtain
108
]
]
]

dt t z
b
a , a
F t
) 1 ( ) a (
) 1 a (
2
3 2
1 2
1
0
1 a
1
1
1
]
]
]
+
z
b , 1 a
a , a , a
F
2 1
3 2 1
2 3
(B.9)
Therefore
]
]
]
+ +

+

+

z
1 , 1 p
, , p
F dt ) t z ; 1 ; , ( F t
) 1 ( ) p (
) 1 p (
2 3
1
0
1 2
1 p
(B.10)
where as usual, ) p ( p ) 1 p ( + .
We thus arrive at
+

t
0
t
0
t
dt ) e C ; 1 ; , ( F e

'
'
]
]
]
+ +

]
]
]
+ +

0 2 3
t
0 2 3
t
C
1 , 1 p
, , p
F e C
1 , 1 p
, , p
F e
p
1
(B.11)
where p is given by (B.4).
For the generalized hypergeometric functions the reader may consult Andrews,
Askey and Roy [4], Erdlyi [10], Rainville [25], or Slater [31] among a plethora of
monographs.
Note. The generalized hypergeometric function is defined by

+
]
]
]
1 n
n
q
1 j
n j
p
1 i
n i
q 2 1
p 2 1
q p
! n
z
) b (
) a (
1 z
b , , b , b
a , , a , a
F
If q p the series converges for all finite z. If 1 q p + , the series converges for
1 | z | < .
References.
[1] M. Abramowitz and I. Stegun: Handbook of Mathematical Functions
109
Dover 1972
[2] D. Acemoglu: Introduction to Modern Economic Growth
Princeton University Press 2009
[3] P. Aghion and P. Howitt: Endogenous Growth Theory
MIT Press 1998
[4] G.E. Andrews, R. Askey and R.Roy: Special Functions
Cambridge University Press 1999
[5] R. Barro and X. Sala-i-Martin: Economic Growth
MIT Press, Second Edition, 2004
[6] J. Benhabib and R. Perli: Uniqueness and indeterminacy: On the
Dynamics of Endogenous Growth
Journal of Economic Theory 63 (1994) 113-142
[7] D. Bethmann: A Closed-Form Solution of the Uzawa-Lucas Model of
Endogenous Growth
Journal of Economics 90 (2007) 87-107
[8] R. Bucekkine and J. R. Ruiz-Tamarit: Special functions for the study
of economic dynamics: The case of the Lucas-Uzawa model
Journal of Mathematical Economics 44 (2008) 33-54
[9] J. Caball and M. Santos: On Endogenous Growth with Physical and
Human Capital
Journal of Political Economy 101 (1993) 1042-1067
[10] A. Erdlyi (Ed.): Higher Transcendental Functions
Volume 1, McGraw Hill 1953
[11] M.A. Gmez: Optimal Fiscal Policy in the Uzawa-Lucas model with
Externalities
Economic Theory 22 (2003) 917-925
[12] A. Greiner and W. Semmler: The Global Environment, Natural
Resources, and Economic Growth
110
Oxford University Press 2008
[13] A. Greiner, W. Semmler and G. Gong:The Forces of Economic Growth-
A Time Series Approach
Princeton University Press 2005
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returns to scale: Note
Economic Modelling 26 (2009) 831-834
[15] E. L. Ince: Ordinary Differential Equations
Dover 1956
[16] N.N. Lebedev: Special Functions and their Applications
Dover 1972.
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Journal of Monetary Economics 22 (1988) 3-42
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Finace
North-Holland 1982
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the Uzawa-Lucas Model
University of Cagliari Report.
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Ashgate, Aldershot 2002
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Externalities
University of Cagliari Report.
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Volume 1, McGraw Hill, 1953.
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Sector Models of Endogenous Growth
111
Quarterly Journal of Economics 108 (1993) 739-773
[24] L.S. Pontryagin, V.G. Boltyanskii, R.V. Gamkrelidge and E.F.
Mishchenko: The Mathematical Theory of Optimal Processes
Interscience, 1962
[25] E. D. Rainville: Special Functions
Chelsea 1971
[26] P.M. Romer: Increasing Returns and Long-Run Growth
[27] P.M. Romer: Endogenous Technological Change
[28] D. Romer: Advanced Macroeconomics
McGraw Hill, N.Y.1996
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a Natural-Resource-Based Economy
Preprint
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Applications
North-Holland 1987
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Pergamon Press, Oxford 1964. Volume III, Part 2
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International Economic Review 6 (1965) 18-31
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(Eds). Elsevier 2004

The Lucas-Uzawa Models Closed-Form Solutions: Skemsys

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The Lucas-Uzawa Models Closed-Form Solutions: Skemsys

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1

The Lucas-Uzawa Models:

which is equivalent to the equation

is an equation with separable variables with general solution

Therefore it can be written as

which is equivalent to the equation

Dividing equation (3.81) by equation (3.83), we obtain

which is equivalent to the equation

as an integrating factor, where

as an integrating factor, where

Therefore it can be written as

from (6.31) and then substitute the expressions for K and Q

which, because of (7.24), takes on the form

The subsidy can be financed by taxing human capital income at a rate

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