Economic Growth: Ramsey-Cass-Koopman’s Model

Kumarjit Mandal

University of Calcutta

June 2024

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 1 / 18
Introduction

There is one representative consumer

The consumer is both consumer and produce
There is one good that can be either consumed or saved
The consumer lives for ever
The population growth rate is n > 0 where N(t) = N(0)e nt

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 2 / 18
Consumer’s Problem

The representative consumer chooses consumption at all points of time such that
Z ∞
Max u(c(t))e −θt dt (1)
0

subject to
˙ + c(t) = w (t) + (r (t) − n)a(t)
a(t) (2)
Initial wealth a(0) is given
The consumer is price-taker and takes the prices w (t) and r (t) as given
Note: The population growth is subtracted from the the real interest return on on
assets because of the need to provide newly born consumers each point of time with
the same portfolio as all other consumers

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 3 / 18
Consumer’s Problem

Maximize the Hamiltonian

H(c(t), a(t), λ(t), t) = u(c(t)) + λ(t)[w (t) + (r (t) − n)a(t) − c(t)] (3)

First order conditions

∂H
= 0 =⇒ u ′ (c(t)) = λ(t) (4)
∂c(t)
The Hamiltonial for the problem

∂H ˙
˙ =⇒ λ(t) = n + θ − r (t)
= θλ(t) − λ(t) (5)
∂a(t) λ(t)
Transversality condition
lim e −θt λ(t)a(t) = 0 (6)
t→∞

From equation (4), we get

˙ = u”(c(t))c(t)
λ(t) ˙ (7)
Using equation(7) in equation(5), we get
˙
c(t) u ′ (c(t))
= [− ][r (t) − (n + θ)] (8)
c(t) u”(c(t))c(t)

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 4 / 18
Consumer’s Problem

Now
u ′ (c(t))
γ(c(t)) = − (9)
u”(c(t))c(t)
Here γ(c(t) is known as intertemporal elasticity of substitution (IES)
IES considers the relationship between relative changes over time in consumption
and the size of the implied changes in marginal utility

∂(rate of change in u ′ (c(t))) −1 ˙ ′ (c(t))) −1

∂(u ′ (c(t))/u
IES = γ(c(t)) = −( ) = −( )−
∂(rate of change in c(t)) ˙
∂((c(t)/c(t))
(10)
The related concept is elasticity of marginal utility σ(c(t))
1
σ(c(t)) = (11)
γ(c(t))

Then equation(8) can be written as

˙
c(t) 1
= [r (t) − (n + θ)] (12)
c(t) σ(c(t))

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 5 / 18
Firm’s Problem

The firm maximizes its profit every point of time

The profit function of the firm

F (K (t), L(t)) − w (t)L(t) − (r (t) + δ)K (t) (13)

The optimal conditions are

∂F ((K (t), L(t))
= f ′ (k(t) = δ + r (t) (14)
∂K (t)
And
∂F ((K (t), L(t))
= f (k(t) − f ′ (k(t))k(t) = w (t) (15)
∂L(t)

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 6 / 18
General Equilibrium: Competitive Market Equilibrium

Given an initial condition k(0), a competitive equilibrium is a vector of continuous

functions of time defined over (0, ∞) [c ∗ (t), k ∗ (t), w ∗ (t), r ∗ (t), L∗ (t), a∗ (t)]∞
t=0 such
that
Given w ∗ (t),r ∗ (t) the functions c ∗ (t) and a∗ (t) solve the consumer’s problem,
Given w ∗ (t),r ∗ (t) the capital k ∗ (t) maximizes the firm’s profit
The labour market clears −→ Since labour is supplied inelastically, the labour
demand is equal to total population −→ L∗ (t) = N ∗ (t) = N(0)e nt
The capital market clears−→ The units of stock owned by the households is equal to
the stock of capital owned by firms −→ a∗ (t) = k ∗ (t)

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 7 / 18
Resource Constraint of the Economy

Combine equations (14), (15) and (2) and the equilibrium relation a∗ (t) = k ∗ (t)
˙ = f (k(t)) − (n + δ)k(t) − c(t)
k(t) (16)

This is the resource constraint of the economy

It reflects the Walras’ Law
It signifies that total production in the economy, in equilibrium, is equal to
consumption and investment
˙ + (n + δ)k(t)]
f (k(t)) = c(t) + [k(t) (17)

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 8 / 18
Social Planner’s Equilibrium

There is continuous population growth at the rate n > 0, so that N(t) = N(0)e nt
Existing consumers give away some resources to endow new agents at birth with the
same units of capital they already own
The social planner maximises the utility of the representative consumer
The constraint for him is the available resource, which is given in per capita terms as
in equation (17)
Alternatively, derive it as
Y (t) = C (t) + I (t) (18)
˙ + δK (t)
Since I (t) = K (t)
˙ + δK (t)
Y (t) = C (t) + K (t) (19)

Dividing equation (19) by N(t)

Y (t) C (t) ˙
K (t) K (t)
= + +δ (20)
N(t) N(t) N(t) N(t)
In per capita terms
˙ + (n + δ)k(t)
y (t) = f (k(t)) = c(t) + k(t) (21)

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 9 / 18
Social Planner’s Equilibrium: Optimal Conditions

The optimization problem looks like

Z ∞
Max u(c(t))e −θt dt (22)
0

subject to
˙ = f (k(t)) − (n + δ)k(t) − c(t)
k(t) (23)
H(c(t), a(t), µ(t), t) = u(c(t)) + µ(t)[f (k(t)) − (n + δ)k(t) − c(t)] (24)
The first order optimal conditions

u ′ (c(t)) − µ(t) = 0 (25)

˙
µ(t)
f ′ (k(t)) − (n + δ) − θ + =0 (26)
µ(t)
lim e −θt µ(t)k(t) = 0 (27)
t→∞

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 10 / 18
Social Planner’s Equilibrium: Optimal Conditions

Combining equations (25) and (26)

′
˙ = u (c(t)) [(n + δ) + θ − f ′ (k(t))]
c(t) (28)
′′
u (c(t))
This is known as Keynes-Ramsey rule
This can be written as

˙
c(t) 1
= [f ′ (k(t)) − (n + θ) − δ] (29)
c(t) σ(c(t))

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 11 / 18
Welfare Theorems

Theorem 1
First Welfare Theorem: Every Competitive Equilibrium is social planner’s optimum
solution, provided there is no externality and no missing market

Theorem 2
Second Welfare Theorem: Every Social planner’s optimum solution can be
decentralized as a competitive equilibrium

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 12 / 18
Equivalence

Define λ(t) = µ(t)

Equation(4) implies equation(25)
If we substitute equation(13) into equation(5), we obtain equation(26)
Then equation(6) implies equation(27)
The budget economy’s resource constraint in the competitive equilibrium solution is
same as resource constraint for the social planner
Hence competitive equilibrium solution solves the social planners problem

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 13 / 18
Graph 1: Dynamics of c

c
ċ = 0

˙ >0
c(t) ˙ <0
c(t)

k∗ k

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 14 / 18
Graph 2: Dynamics of k

˙ <0
k(t)

k̇ = 0

˙ >0
k(t)

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 15 / 18
Graph 3: Dynamics of c and k

c
ċ = 0

E
k̇ = 0

k∗ kGR k

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 16 / 18
Graph 4: The Behaviour of c and k for Various Initial Values of c

c
ċ = 0

E
B k̇ = 0
C
F
D

k(0) k ∗ k

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 17 / 18
Graph 5: The Saddle Path

c
ċ = 0

E
k̇ = 0

k∗ k

Kumarjit Mandal (University of Calcutta) Economic Growth: Ramsey-Cass-Koopman’s Model June 2024 18 / 18