First GGenerationon Madelsis

off Endiogenousu Growthouth

Solow and R C K framework do not

explain what drives economic growth in
the long run

Using First Generation Models of Endogenous

Growth we eliminate the long run tendency
for diminishing returns to capital

We combine AK production tech with

optimizing behaviour of firms HH

AK MODEL WITH HUMAN CAPITAL

Large no of identical infinitely lived HH
with same preferences
Let ent
HH own financial assets labour distributed
equally
Wages interest rate given
Savings through accumulating assets
 nga ng
a rat wi c na
HH can provide capital service or lead to
other HH
R service
rental price of capital
r roi on funds lent to other HH
r R S
No Ponzi condition
fotercu n du
o
limp acts e

Each HH decides how much to consume

how much to save by maximizing
lifetime utility

Utility Maximisation
rent
Ici
U e at O 14020

s t act ret alt wet CH halt

Im
act e
Stern ndu o IG
setting up the Hamiltonian
t Dtt Mct
H II e ret alt wet est
 i o
I l nacts

Solving Foes
t ME
U'Cece e yet
31,50
C O
et I pct
Taking log on both sides
Olage Cp Nt log Mct
Diff W r t t
O D
E G ye
But Mct ret n
21 ME
i O th A rct
E p

Effects p

Tve
Iim Mct alt o

AK MODEL FIRMS
Firms
operate in a competitive structure
All firms are identical representative firm
Now unlike R C K firms have a linear
production function
AR A o
Y
Constant marginal product
Inada conditions are violated
Imi tick A
first'm
IT LCH CAR RR W
Let A R 0
II E
R A RLE t S
r A S
w
III
i MP of labour is zero rate is zero
wage
Hence in AK Model no labour is hired
by firms
i
interest inconne ie the only source of
income of households

AK MODEL GENERAL EQUILIBRIUM

Factor market clears
Ket is given demand for capital
 cap
comes from MPR r
Due to closed all debt within
economy
the out
economy cancel
i Asset worker k
per person capital per
Using
a K V A S W o in 950

K CA S N R C

A S
É to p
CA s m
Ket e I o go
Iim
Equilibrium growth rate of per capita cons
is constant
We can determine act for any eco
by integrating
É tola
S P

S p
CECA
s at
fide FICA e

Cet co S t
log log ILA p
n s pst
 e tea s p
EI
to A S Pt
i
Clt Ceo q
For A S
positive growth P
remain bounded
For
utility to
p n
life
CA S p
n
p
coff ee
n

aged
P it

no d o A S
p
Adding s both sides
S I O CA S not 8
Pt
Parametric restrictions
A p 8 A 8 Ci O On s

TRANSITIONAL DYNAMICS
a s
to p
Yola s 1st
Cet Ceo e
 From K A S Nk C
Yola S pit
k A S n R Ceo e

This is a first order linear differential

eg in K
General Solution

kit et
s t
e gotta s Pt A s not
gogo de

e'a
I
a s n't
C G

s A S pst
Ritt C ela my
age
At t O K 10 is known
RIO G
If
a Rio 4

time
path of KCH is given by
s s Pt
RCH RIO era my ellora
Go leg
when be written as
we ca 8 n
COI f
And also as W CA S n A S p
I
A S M T
ensures that w o

TVI Act RCH

la S nst o
Ket e
Tim
Substituting from
s s.pt
I riot
cigjet mttqy.etia
CA S n
Xe

I ko
ego cog et I
4
II no
711 5
0
 RIO D

Tuc holds CCO RCO co

only if
HH choose CCO S t
Ceo A S N r K O
10 G N V RIO
CA th't
If CIO w ko then key O

Tuc is violated HH over save

a s
If Clo who then ret e co
fly
TVC is violated HH over consume

i o W RCO
back in
Substituting
RCH e loca 8 pst
Cy A
co Rct
ccos.gl sm
CLE WALE
This A S
É É I p
means

Y AK CA S p
to
Y
No transitional dynamics
From start the
system is in balanced
s t Ct wkets
growth path

Saving rate
Total KII
ktnykts s a
ktngff ptg.to
PHASE DIAGRAM

A Clt yo
pts
i Lets 0 doesn't exist

K O K CA S N R C o

A S n k c is the eg of K O
 i o cc n'm

7 sad

is
Eastin rm

The Tuc Euler's eg ensure that the

economy is always on the saddle path

C k is
always constant

In the Ak growth is endogenous

model
in the sense that there is a the per
capita growth in the long run generated
by the internal mechanism in the model
not
by exogenous tech growth

Capital accumulation explains the sustained

per capita growth

SOCIAL PLANNER'S PROBLEM

U etat O
f c'Igent
e 1 o o

S t K A S NK C

CCH 3,0 RCO given

This yields the same outcome as the
decentralised egm

Ak vs R C K
In AK Model the
long run short run

growth rate depends on parameters

that determine the willingness to save
productivity of capital
if E f ca s
p
Low p O Higher per capita growth rate
High A High per capita growth rate

In the R C K Model per capita

long sun

growth rate exogenous rate of tech Chang

Greater willingness to save improvement
in tech hae level effects but no growth
effect on per capita variables
 cap

Pace ofdiminishing returns determines

how quickly the economies converge
If convergence is rapid there's substantial
beth AK neoclassical models
diff

ONE SECTOR MODEL

WITH PHYSICAL AND HUMAN CAPITAL
Including human capital
Y F K H
Fl neoclassical properties CRS on K H
i Y K F I H K K f H K
f HR 70

Depreciation SK SH
ki Ik S K K H In SH H
Population L constant
Ric Ra Rental capital paid by firms
2 f Ef Rk
E
f th Ra
3
 Rate of return to capital owners

RK SK RH SH
In egm R Su Re Sk r interest rate

i we get f fi 1 Sie 8u
t Itt
A
If we take f y
then Y AK

this is same as AK Model

At egm we have constant equal growth
rate C K Y
of
MODELS WITH LEARNING BY DOING
AND KNOWLEDGE SPILLOVERS
Models with knowledge spillover effects
eliminate the
tendency for diminishing
returns to capital accumulation so
economic growth is endogenously determined

knowledge creation is
a side
Assumption
product of net investment in physical
capital
learning by doing A firm that increases
it physical capital learns simultaneously
how to produce more
efficiently
Each firm's knowledge is a public good

THE MODEL SETUP

Closed perfect competition
economy
Neoclassical prod fu Fl with CRS
Yi FC ki Ai Li
Ai indexof knowledge available to the firm
Ai is labour augmenting
L is constant labour force
learning by doing
o

I in net investment ki t in Ai
Ai is overall
change in the economy's
overall learning A
It is proportional to k
Ai B k Ai BK
If B 1 Ai K
Yi FC ki Ai Li F Ki K L
If K Li are constant each firm faces
diminishing returns to Ki
 hung
When Ki
expands H i k rises has
a spillover effet
CRS when Ki kexpand together for
fixed L This yields endogenous growth
Yi FCKi K
i Yi Li F ki K

IT F Ki k Li rts ki w Li

Ti Li Chi k rts ki w

Each
firm's investment has a
negligible effect on economy wide
K is
knowledge level A given
F hi K rt 8 o
II F Cri K rt 8
W O
FC ki k Yi F ki K
JI
ki F Ri k
FI ki k W

F1 I is neoclassical Fi Ri K LO
i Ri is determined uniquely
Fil ki Ri Fi ki K
3ft KYE.it zFyRiik tip
 KÉ concave fun

Since firms are

perfectly competitive
Ri k f firms

Ki K L K4 I
In egm Eli given
K Ki Ri Li
RE Li R L

K R L in egm

Yi y FCK K

Eam in Factor Markets

Fl ki k FIR K
F Rik F 1 Kp Fll L flu
Ip I
K L L constant 180
Y f
AP YIK is invariant in k but
in L
increasing
f 4
If
i Prod fr is linear in K i there are
constant returns to capital
From 160 r F Ck K S
F Ck K D L f L
f
L S
r
f L f L
W FCK K R F CR K
FIR K R
f f FllL Ll Lf L

F RK F R K K f L
W K f L

HOUSEHOLD'S PROBLEM
Pldt
cif
Max U Of 1 030
L
e

S t ait ret ACH wet Clt

fit inundu
finna act e I o
NPC

Setting up the Hamiltonian

H
CI e Ptt acts wits
petty
frets city
 i o l
Solving Foes
É to
ret p
Tvc Limp pelts alt 0

In egm r
f L L f L S
s
4 f fu i t cu p
This rate is constant
growth as long as

I is constant

Assumption Parameters are such that

growth rate is positive but not large
enough to yield infinite utility

flu L
flu pts
t off it
PIE
Putting a k values r w in
of
asset accumulation eg
K R f L C SR 260
This model has no transitional
 KY C constant
dynamics grow at a

rate given 240

by
PARETO OPTIMALITY
Unlike individual firms a social
planner
recognizes that each firms increase in
capital stock adds to the aggregate
capital stock and hence contributes to
the productivity of all the firms in
the
economy
i a social
planner internalizes the
all
knowledge spillovers across
firms
FOC with social planner
s
I to far p

flu L f ca c
f ell CE É
i
per capita growth is too low in
decentralised egm it is not
pareto
optimal
 Social optimum can be reached
by
subsidizing purchases of capital goods
or
subsidizing production
Expansion of aggregate labor force l
raises the per capita growth for both
centralized decentralized economies
hence has a scale
effect
Prediction is that
countries with
workers tend to
more
grow faster in
per capita terms