GOLDEN RULE Flashcards
What do we want to maximise in the steady state?
MAX consumption since utility = f(consumption)
Necessary condition for steady state
i* = d bar K*
Consumption =
difference between output and investment.
Max consumption is given by
Where depreciation line tangent to production function (slopes equal).
MPK = depreciation rate
Why is increasing K beyond K* gold not optimal?
Because then MPK < d so marginal benefit of additional investment < marginal cost of investment needed to sustain the steady state.
If we start with too much capital, explain transition to K* gold.
Need to lower s bar = investment curve pivots down. Consumption increases on impact, then decreases slightly as K falls but is still higher. Y and I fall.
If we have K* > K* gold, it is efficient?
NO - the original steady state is dynamically inefficient as we can increase C in LR without SR trade-off.
If we start with too little capital, explain transition to K* gold.
Need to raise s bar = investment curve pivots up. Investment rises on impact, C falls. Eventually get higher I, higher Y, higher C.
If we have K* < K* gold, it is efficient?
YES - the original steady state is dynamically efficient as we cannot raise C LR without reducing it SR = trade-off and generational conflict.
Why is it hard to provide rigorous statements on efficiency with solow?
because consumption is not based on a utility function - could actually have myopic/impatient agents who discount future C a lot so efficient K* could < K* gold.
