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Recursive Economics

Recursive economics

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122 views3 pages

Recursive Economics

Recursive economics

Uploaded by

Econometrista Iel Emecep
Copyright
© © All Rights Reserved
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Recursive economics

Recursive economics is a branch of modern economics based on a paradigm of individuals making


a series of two-period optimization decisions over time.

Contents
Differences between recursive and neoclassical paradigms
The recursive model
Pioneers in the field
Applications in economics
See also
References

Differences between recursive and neoclassical paradigms


The neoclassical model assumes a one-period utility maximization for a consumer and one-period
profit maximization by a producer. The adjustment that occurs within that single time period is a
subject of considerable debate within the field, and is often left unspecified. A time-series path in the
neoclassical model is a series of these one-period utility maximizations.

In contrast, a recursive model involves two or more periods, in which the consumer or producer trades
off benefits and costs across the two time periods. This trade-off is sometimes represented in what is
called an Euler equation. A time-series path in the recursive model is the result of a series of these two-
period decisions.

In the neoclassical model, the consumer or producer maximizes utility (or profits). In the recursive
model, the subject maximizes value or welfare, which is the sum of current rewards or benefits and
discounted future expected value.

The recursive model


The field is sometimes called recursive because the decisions can be represented by equations that
can be transformed into a single functional equation sometimes called a Bellman equation. This
equation relates the benefits or rewards that can be obtained in the current time period to the
discounted value that is expected in the next period. The dynamics of recursive models can sometimes
also be studied as differential equations.

Pioneers in the field


The recursive paradigm originated in control theory with the invention of dynamic programming by
the American mathematician Richard E. Bellman in the 1950s. Bellman described possible
applications of the method in a variety of fields, including Economics, in the introduction to his 1957
book.[1] Stuart Dreyfus, David Blackwell, and Ronald A. Howard all made major contributions to the
approach in the 1960s.
In addition, some scholars also cite the Kalman filter invented by Rudolf E. Kalman and the theory of
the maximum formulated by Lev Semenovich Pontryagin as forerunners of the recursive approach in
economics.

Applications in economics
Some scholars point to Martin Beckmann and Richard Muth[2] as the first application of an explicit
recursive equation in economics. However, probably the earliest celebrated economic application of
recursive economics was Robert Merton's seminal 1973 article on the intertemporal capital asset
pricing model.[3] (See also Merton's portfolio problem). Merton's theoretical model, one in which
investors chose between income today and future income or capital gains, has a recursive formulation.

Nancy Stokey, Robert Lucas and Edward Prescott describe stochastic and non-stochastic dynamic
programming in considerable detail, giving many examples of how to employ dynamic programming
to solve problems in economic theory.[4] This book led to dynamic programming being employed to
solve a wide range of theoretical problems in economics, including optimal economic growth, resource
extraction, principal–agent problems, public finance, business investment, asset pricing, factor supply,
and industrial organization.

The approach gained further notice in macroeconomics from the extensive exposition by Ljungqvist &
Sargent.[5] This book describes recursive models applied to theoretical questions in monetary policy,
fiscal policy, taxation, economic growth, search theory, and labor economics.

In investment and finance, Avinash Dixit and Robert Pindyck showed the value of the method for
thinking about capital budgeting, in particular showing how it was theoretically superior to the
standard neoclassical investment rule.[6] Patrick Anderson adapted the method to the valuation of
operating and start-up businesses [7][8] and to the estimation of the aggregate value of privately held
businesses in the US.[9]

There are serious computational issues that have hampered the adoption of recursive techniques in
practice, many of which originate in the curse of dimensionality first identified by Richard Bellman.

Applied recursive methods, and discussion of the underlying theory and the difficulties, are presented
in Mario Miranda & Paul Fackler (2002),[10] Meyn (2007)[11] Powell (2011)[12] and Bertsekas
(2005).[13]

See also
Dynamic programming
Hamilton–Jacobi–Bellman equation
Markov decision process
Optimal control theory
Optimal substructure
Recursive competitive equilibrium
Bellman pseudospectral method

References
1. Dynamic Programming Princeton, 1957; reissued by Dover
2. Martin Beckmann and Richard Muth, 1954, "On the solution to the fundamental equation of
inventory theory," Cowles Commission Discussion Paper 2116.
3. Robert C. Merton, 1973, "An Intertemporal Capital Asset Pricing Model," Econometrica 41: 867–
887.
4. Nancy Stokey, and Robert E. Lucas, with Edward Prescott, 1989. Recursive Methods in Economic
Dynamics. Harvard Univ. Press.
5. Lars Ljungqvist & Thomas Sargent, 2000, 2004, 2012. Recursive Macroeconomic Theory. MIT
Press.
6. Avinash Dixit & Robert Pindyck, 1994. Investment Under Uncertainty. Princeton Univ. Press.
7. Anderson, Patrick L., Business Economics & Finance, CRC Press, 2004, ISBN 1-58488-348-0.
8. Anderson, Patrick L., Economics of Business Valuation, Stanford University Press, 2013
9. The Value of Private Businesses in the United States, Business Economics (2009) 44, 87–108.
doi:10.1057/be.2009.4 (https://doi.org/10.1057%2Fbe.2009.4).
10. Miranda, M., & Fackler, P., 2002. Applied Computational Economics and Finance. MIT Press
11. S. P. Meyn, 2007. Control Techniques for Complex Networks (http://decision.csl.uiuc.edu/~meyn/p
ages/CTCN/CTCN.html) Archived (https://web.archive.org/web/20080513165615/http://decision.cs
l.uiuc.edu/~meyn/pages/CTCN/CTCN.html) 2008-05-13 at the Wayback Machine, Cambridge
University Press, 2007. Meyn & Tweedie (http://decision.csl.uiuc.edu/~meyn/pages/book.html)
Archived (https://web.archive.org/web/20071012194420/http://decision.csl.uiuc.edu/~meyn/pages/
book.html) 2007-10-12 at the Wayback Machine,
12. Warren B. Powell, Approximate Dynamic Programming, 2d ed. Wiley, 2011,
13. Dimitri Bertsekas, Dynamic Programming and Optimal Control, Athena Scientific 2005, 2012

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