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Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Growth Theory: ReviewLecture 1.2, Endogenous Growth
Topics in Growth, Part 2
June 11, 2007
Lecture 1.2, Endogenous Growth 1/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Outline
Review: From Solow to Ramsey to Endogenous GrowthReview: Solow ModelReview: 1SGM
Ak model: A simple model of endogenous long-run growth:SetupGrowth rates are constantGrowth rates of c, k and y are the sameBalanced growth path theorem
Akh model: endogenous growth with human capitalSetupSocial Planner’s problemEuler equationOptimal k/h ratio and consumption growth rate
Akh and Ak equivalence
Lecture 1.2, Endogenous Growth 2/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Review: Solow ModelReview: 1SGM
Review: Solow Model 3
Solow Model
◮ Exogenously given savings rate s◮ Production function
◮ Assumptions:
→ A1: Constant returns to scale (CRS)F (λK , λL) = λF (K , L)
→ A2: Marginal products positive and diminishingFK > 0, FL > 0, FKK < 0, FLL < 0
◮ From CRS (A1), we can write F in per capita termsf (k) = F (k , 1). Then (A2) becomes
FK > 0 ⇔ f ′(k) > 0FKK < 0 ⇔ f ′′(k) < 0
◮ For example, f (k) = Akα with α < 1Lecture 1.2, Endogenous Growth 3/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Review: Solow ModelReview: 1SGM
Review: Solow Model → Results 4
Solow Model
◮ Unless there is exogenous technological change(At+1 = (1 + g)At , g > 0), the economy converges to asteady state in per capita variables.
◮ No long-run growth except due to technological change.
◮ Golden Rule steady state level of consumption requiress = α
Investments result from choices: the Solow model has nothingto say about savings/investment decisions → 1SGM
Lecture 1.2, Endogenous Growth 4/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Review: Solow ModelReview: 1SGM
Review: 1SGM 5
1SGM
◮ Households choose how much to save and how much toconsume → dynamics results from this choice.
◮ Production function: same as for the Solow model◮ Assumptions (Lecture 3):
→ A1: Constant returns to scale (CRS)→ A2: Marginal products positive and diminishing
◮ From CRS (A1), we can write F in per capita termsf (k) = F (k , 1). Then (A2) becomes
FK > 0 ⇔ f ′(k) > 0FKK < 0 ⇔ f ′′(k) < 0
◮ For example, f (k) = Akα with α < 1
Lecture 1.2, Endogenous Growth 5/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Review: Solow ModelReview: 1SGM
Review: 1SGM → Results 6
1SGM
◮ Unless there is exogenous technological change(At+1 = (1 + g)At , g > 0), the economy converges to asteady state in per capita variables (g = 0).
◮ No long-run growth except due to technological change.◮ Modified Golden Rule steady state level of consumption
and capital are smaller than Golden Rule. This is due toimpatience of households.
◮ If government consumption is financed with taxes oncapital gains, HH save less and the steady state (c∗τk ) and(k∗τk ) are lower than with LS taxes.
How does long-run growth occur endogenously?
Lecture 1.2, Endogenous Growth 6/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupGrowth rates are constantGrowth rates of c, k and y are the sameBalanced growth path theorem
A simple model of endogenous long-run growth 7
Ak Model
◮ Take 1SGM but change 1 assumption: α = 1
◮ Thus the production function becomes: f (k) = Ak (orF (K , L) = AK , i.e. labor does not enter into the productionfunction)
◮ That is, f ′(k) = A > 0 → used in Euler equation◮ That is, f ′′(k) = 0. There are no more diminishing marginal
returns to capital. It is constant returns to capital alone!
How does long-run growth occur endogenously?
Lecture 1.2, Endogenous Growth 7/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupGrowth rates are constantGrowth rates of c, k and y are the sameBalanced growth path theorem
Growth rate of consumption and the Euler equation 8
Ak Model
◮ The Euler equation becomes:
ct+1
ct= [β(f ′(kt+1) + 1 − δ)]1/σ
ct+1
ct= [β(A + 1 − δ)]1/σ = 1 + γc
◮ There is no steady state in this model
◮ But clearly, consumption grows at a constant rate—
FOREVER!!!
Lecture 1.2, Endogenous Growth 8/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupGrowth rates are constantGrowth rates of c, k and y are the sameBalanced growth path theorem
Growth rate of consumption and the Euler equation 9
Ak Model: Assumption 1
ct+1
ct= [β(A + 1 − δ)]1/σ = 1 + γc
◮ Assumption 1: γc > 0
This requires: β(A + 1 − δ) > 1
Lecture 1.2, Endogenous Growth 9/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupGrowth rates are constantGrowth rates of c, k and y are the sameBalanced growth path theorem
Growth rate of capital and the resource constraint 10
Ak Model: The growth rate of capital is constant
◮ The resource constraint can be written as:
ct + kt+1 = (A + 1 − δ)kt
Dividing both sides by kt
ct
kt+
kt+1
kt= A + 1 − δ
Lecture 1.2, Endogenous Growth 10/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupGrowth rates are constantGrowth rates of c, k and y are the sameBalanced growth path theorem
Growth rate of capital and the resource constraint 11
Ak Model: The growth rate of capital is constant
ct
kt+
kt+1
kt= A + 1 − δ
◮ Suppose the growth rate of k is increasing over time
→ctkt
must be decreasing over time→ violates transversality condition
◮ Suppose the growth rate of k is decreasing over time
→ctkt
must be increasing over time→ drives k and in turn c to 0, cannot be optimal
◮ Thus, kt+1kt
= 1 + γk is constant
Lecture 1.2, Endogenous Growth 11/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupGrowth rates are constantGrowth rates of c, k and y are the sameBalanced growth path theorem
Equal growth rates 12
Ak Model: Equal growth rates γc = γk = γy
ct
kt+ (1 + γk ) = A + 1 − δ
◮ Thus the ratio of consumption to capital is constant
◮ Thus, capital and consumption must grow at the same rate
◮ Since yt = Akt , output per capita must be growing at thesame rate as well
Thus, γ = γc = γk = γy = [β(A + 1 − δ)]1/σ − 1
Lecture 1.2, Endogenous Growth 12/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupGrowth rates are constantGrowth rates of c, k and y are the sameBalanced growth path theorem
Conditions for a BGP to exist 13
Ak Model: Assumption 2
ct
kt+ (1 + γk ) = A + 1 − δ
ct
kt+ [β(A + 1 − δ)]1/σ = A + 1 − δ
ct
kt= (A + 1 − δ)(1 − β
1σ (A + 1 − δ)
1σ−1)
◮ Assumption 2:
β1σ (A + 1 − δ)
1σ−1 < 1
Lecture 1.2, Endogenous Growth 13/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupGrowth rates are constantGrowth rates of c, k and y are the sameBalanced growth path theorem
Conditions for a BGP to exist 14
Ak Model: TheoremConsider the social planner’s problem with linear technologyf (k) = Ak and CEIS preferences. Suppose (β, σ, A, δ) satisfy
β(A + 1 − δ) > 1 > β1σ (A + 1 − δ)
1σ−1
Then the economy exhibits a balanced growth path wherecapital, output and consumption all grow at a constant rategiven by
kt+1
kt=
yt+1
yt=
ct+1
ct= 1 + γ = [β(A + 1 − δ)]1/σ
The growth rate is increasing in A and β and it is decreasing inδ and σ.
Lecture 1.2, Endogenous Growth 14/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupSocial Planner’s problemEuler equationOptimal k/h ratio and consumption growth rate
Setup: Production function 15
Production function with human capital
Yt = F (Kt , Ht) = F (Kt , htLt)
◮ F : Neoclassical production function:
→ A1: Constant returns to scale (CRS)F (λK , λH) = λF (K , H)
→ A2: Marginal products positive and diminishingFK > 0, FH > 0, FKK < 0, FHH < 0
→ Use CRS , write F in per capita terms F (K ,H)L = F (k , h)
→ For example, f (k , h) = Akαh1−α with α < 1
◮ Ht = htLt is effective labor.
Lecture 1.2, Endogenous Growth 15/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupSocial Planner’s problemEuler equationOptimal k/h ratio and consumption growth rate
Setup: Investments and Resource constraint 16
Capital-type specific investment
ikt : investment in physical capital
iht : investment in human capital
Resource constraintTotal output can be used for consumption or investment ineither type of capital.
ct + ikt + iht = F (kt , ht)
Lecture 1.2, Endogenous Growth 16/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupSocial Planner’s problemEuler equationOptimal k/h ratio and consumption growth rate
Setup: Investments and depreciation 17
Laws of motion
kt+1 = ikt + (1 − δ)kt
ht+1 = iht + (1 − δ)ht
Resource constraint can be written as
ct + kt+1 + ht+1 = F (kt , ht) + (1 − δ)kt + (1 − δ)ht
Lecture 1.2, Endogenous Growth 17/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupSocial Planner’s problemEuler equationOptimal k/h ratio and consumption growth rate
Social Planner’s problem 18
With the usual utility function, Social planner’s problemcan be written as
max(kt+1,ct)
∞
t=0
∞∑
t=0
βtu(ct)
s.t.
ct + kt+1 + ht+1 = F (kt , ht) + (1 − δ)kt + (1 − δ)ht ,
for all t = 0, 1, 2, ...
k0, h0 > 0 given
Lecture 1.2, Endogenous Growth 18/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupSocial Planner’s problemEuler equationOptimal k/h ratio and consumption growth rate
Social Planner’s problem 19
Assume u(c) = c1−σ
1−σ
Assume F (k , h) = Akαh1−α
With functional forms, the planner’s problem becomes
max(kt+1,ct)
∞
t=0
∞∑
t=0
βt c1−σt
1 − σ
s.t.
ct + kt+1 + ht+1 = Akαt h1−α
t + (1 − δ)kt + (1 − δ)ht , for all t
k0, h0 > 0 given
Lecture 1.2, Endogenous Growth 19/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupSocial Planner’s problemEuler equationOptimal k/h ratio and consumption growth rate
Euler equations 20
Since there are 2 types of capital, we have 2 Euler eqnsEuler equation for physical capital
ct+1
ct= [β(1 + Fk (kt+1, ht+1) − δ)]1/σ
ct+1
ct= [β(1 + Aα
(
ht+1
kt+1
)1−α
− δ)]1/σ
Euler equation for human capital
ct+1
ct= [β(1 + Fh(kt+1, ht+1) − δ)]1/σ
ct+1
ct= [β(1 + A(1 − α)
(
kt+1
ht+1
)α
− δ)]1/σ
Lecture 1.2, Endogenous Growth 20/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupSocial Planner’s problemEuler equationOptimal k/h ratio and consumption growth rate
Rate of return condition and k/h ratio 21
Combining Euler equations, we get
Fh(kt+1, ht+1) = Fk (kt+1, ht+1)
or,
Aα
(
ht+1
kt+1
)1−α
= A(1 − α)
(
kt+1
ht+1
)α
Hence, the optimal ratio of physical to human capital is given by
kt+1
ht+1=
α
1 − α
Notice that it is constant. Hence, they grow at the same rate.
Lecture 1.2, Endogenous Growth 21/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
SetupSocial Planner’s problemEuler equationOptimal k/h ratio and consumption growth rate
Growth rate of consumption 22
Using the k/h ratio in either one Euler equation, we find
ct+1
ct= [β(1 + A(1 − α)
(
kt+1
ht+1
)α
− δ)]1/σ
ct+1
ct= [β(1 + A(1 − α)
(
α
1 − α
)α
− δ)]1/σ
ct+1
ct= [β(1 + A(1 − α)1−ααα
− δ)]1/σ
Lecture 1.2, Endogenous Growth 22/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Existence of BGP and Growth rates 23
Using the k/h ratio in laws of motion
We found kt+1ht+1
= α1−α
Therefore,
ht+1 =1 − α
αkt+1 =
1 − α
α(ikt + (1 − δ)kt )
Also,
ht+1 = iht + (1 − δ)ht = iht + (1 − δ)1 − α
αkt
Hence,
iht =1 − α
αikt
Lecture 1.2, Endogenous Growth 23/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Existence of BGP and Growth rates 24
By redefining the variables as follows, this model isequivalent to an Ak modelThis is very useful since we know the conditions on parametersfor the Ak model so that a BGP exists and we know theproperties in terms of growth rates.
Let it = 1α ikt , A = A(1 − α)1−ααα and kt = 1
αkt
Then we can rewrite the resource constraint and laws of motionas follows*
ct + it = Akt
kt+1 = it + (1 − δ)kt
Lecture 1.2, Endogenous Growth 24/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Existence of BGP and Growth rates 25
The social planner’s problem becomes
max(kt+1,ct)
∞
t=0
∞∑
t=0
βt c1−σt
1 − σ
s.t.
ct + kt+1 = Akt + (1 − δ)kt , for all t
k0 > 0 given
This is just an Ak model. Using the conditions on parametersfrom the Theorem... we find
Lecture 1.2, Endogenous Growth 25/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Balanced growth path theorem for Akh model 26
Akh Model: TheoremConsider the social planner’s problem with linear technologyf (k) = Ak and CEIS preferences. Suppose (β, σ, A, δ, α) satisfy
β(A + 1 − δ) > 1 > β1σ (A + 1 − δ)
1σ−1
β(A(1−α)1−ααα + 1− δ) > 1 > β1σ (A(1−α)1−ααα + 1− δ)
1σ−1
and suppose h0 = 1−αα k0.Then the economy exhibits a
balanced growth path where capital, output and consumptionall grow at a constant rate given by
kt+1
kt=
kt+1
kt=
ht+1
ht=
yt+1
yt=
ct+1
ct= 1 + γ = [β(A + 1 − δ)]1/σ
Lecture 1.2, Endogenous Growth 26/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Concluding remarks 27
◮ This model exhibits long run growth, even though someform of labor is taken into account.
◮ This is because the QUALITY of labor is taken intoaccount.
◮ This quality, human capital, is accumulable.
◮ Therefore the diminishing marginal returns don’t kick in.Both factors grow simultaneously and therefore allow theeconomy to grow FOREVER.
Lecture 1.2, Endogenous Growth 27/28 Topics in Growth, Part 2
Review: From Solow to Ramsey to Endogenous GrowthAk model: A simple model of endogenous long-run growth:
Akh model: endogenous growth with human capitalAkh and Ak equivalence
Think about other production functions 28
1. Capital and land enter the production function,Y = F (K ,L)
→ land is not accumulable, it is fixed→ decreasing marginal products kick in → steady state
→ land is accumulable, e.g. US expansion East to West→ economy expands
2. Capital and population/labor enter the production function,
Y = F (K , L) → labor is not accumulable, it is fixed→ decreasing marginal products kick in → steady state
Y = F (K , N) → population is accumulable→ endogenous fertility models → economy expands
Lecture 1.2, Endogenous Growth 28/28 Topics in Growth, Part 2