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Mathematical Computation
June 2014, Volume 3, Issue 2, PP.44-48
The Life-Cycle Model with Optimal Individual
Years of Schooling and Simulation
-

Donghan Cai
#, 1
, Huan Yang
1
, Zhongbin Chen
2

1. College of Math. & Stat., Wuhan Univ., Wuhan, 430072, P.R. China
2. School of Econ. & Management, Wuhan Univ., Wuhan, 430072, P.R. China
#Email: dhcai@whu.edu.cn
Abstract
In this paper, we use a discrete lift-cycle model to inquire the relationship between the individual saving and years of schooling. It
is proved that there exist optimal years of schooling for individual to maximize his lifetime utility and the optimal years of
schooling increases with respect to the wage growth rate and the quantity of human capital growth rate. The individual saving
behavior and his asset change under different years of schooling is presented by the numerical simulation.
Keywords: Lift-Cycle Model; I ndividual Years of Schooling; I ndividual Saving; Quantity of Human Capital
1 INTRODUCTION
The behavior of individual saving and consumption is an important topic in economic theory
[1-5]
. The life-cycle
theory presented by Modigliani
[1-2]
argued that individual saves part of earning while working for his or her
retirement and his or her net worth is never negative. In Tobins model, the negative net worth appears in individual
early age
[3]
. However, the individual years of schooling is not considered in these models. In the paper
[6]
, the years
of schooling and the quantity of human capital is introduced in a continuous time overlapping generations model to
inquire the role of increased life expectancy in raising human capital investment.
In this paper, the years of schooling and the quantity is integrated to a discrete life-cycle model to study the
relationship between the individual years of schooling and saving behavior. It is proved that there exist optimal years
of schooling for the individual reaching maximal lifetime utility and the optimal individual years of schooling
increases with respect to the wage growth rate and the quantity of human capital. At the end of paper, the individual
saving behavior and his asset change under different years of schooling is presented by the numerical simulation.
2 SETUP THE MODEL
Denote the consumption, asset and wage of individuals who born at time s by
s
t
c ,
s
t
a
s
t
w at time t . The finite
longevity and retiring age are O and T respectively. We assume that individuals start their lives without assets and
end up with no bequest and no debt, i.e.
0
s s
s s
a a
+O
= = (1)
and the wage of individual satisfies

1
1 1
0
( )
0
s
t t
s t T
w g T w s T t s T
s T t s
, s < ,

= , + s s + ,

, + < s + O.

(2)
Where
1
T is the year of schooling and
1
( ) g T is the quantity of human capital as a function of taking the years of
schooling satisfying (0) 1 ( ) 0 g g' = , > .
The individual budget constraint is

-
This work is supported by national natural science foundation of China (No.71271158)

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1
(1 ) 1 1
s s s s
t t t t
a r a w c t s s s
+
= + + , = , + , , + O , (3)
where r is the interest rate.
Hence, the lifetime utility of the individual born at time s is
( )
s
t s s
t
t s
u c |
+O

=
, (4)
where
1
1
|
+
= , 0 > is the rate of time preference and the utility function is specified to be ( ) ln u c c = and the
individual optimal problem is to maximize (4) subject to (1) and (3).
3 THE DYNAMICS OF CONSUMPTION AND ASSET
The Lagrangian to solve the individual optimal problem (6) is
1
1
( ) [(1 ) ]
s s
t s s s s s s
t t t t t t
t s t s
L u c r a w c a |
+O +O

+
= =
= + + + .
The first order condition to solve the optimal problem is (3) and

1
(1 ) 0 1
s s
t t s
t
L
r t s s
a

c
= + + = , = + , , + O,
c
(5)
( ) 0 1
t s s s
t t s
t
L
u c t s s
c
|

c
' = = , = , , + O .
c
(6)
From (5), (6) and
1
( )
c
u c ' = ,
1 1
1
( ) 1
1 1
1 ( )
s s s
t t t
s s s
t t t
u c c
t s s s
r u c c
| |

+ +
+
'
= = = , = , + , , + O .
' +

So,
1
1 1
1
s s
r
t t
c c t s s

+
+ +
= , = , , + O . Let
1
1
r
b

+
+
= , then
1
s t s s
t s
c b c t s s s

= , = , + , , + O. (7)
From (3),
1
1 1 1
2
1 1 1
1
(1 )
(1 )[(1 ) ]
(1 ) (1 ) [ (1 ) ]
(1 ) (1 ) (1 )
s s s s
t t t t
s s s s s
t t t t t
s s s s s
t t t t t
t t
t s s t i s t i s
s i i
i s i s
a r a w c
r r a w c w c
r a w r w c r c
r a r w r c
+


+
= =
= + +
= + + + +
= + + + + + +
= + + + + .
(8)
By (1),
1 1
1 1
(1 ) (1 ) 0
s s
s i s s i s
i i
i s i s
r w r c
+O +O
+O +O
= =
+ + = .
So, from (7),
1
1
1 1
1
(1 )
(1 ) ( ) (1 )
1
s s T
s s i s s i
s i i
i s i s T
r b
c r w g T r w
r b
O O
+O +
+O +O
= = +
+
= + = +
+

and
1
1
1
1
( ) (1 )
(1 )
s T
s s i
s i
i s T
r b
c g T r w
r b
+
+O
O O
= +
+
= + .
+

Theorem 1. The individual optimal consumption path is given by
1
1
1
1 1
( ) (1 )
(1 ) 1
t s
s T
s s i
t i
i s T
r b r
c g T r w
r b

+
+O
O O
= +
| | + +
= + ,
|
+ +
\ .
1 t s s s = , + , , + O. (9)
Theorem 2. The individual optimal asset path is given by

1
(1 ) (1 ) ( ) 1 1
t
s t i s s
t i i
i s
a r r w c t s s s

+
=
= + + , = , + , , + O , (10)
where
s
i
w and
s
i
c are given by (2) and (7) respectively.

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4 THE OPTIMAL YEARS OF SCHOOLING
In this section, we assume that the wage grows at the rate r < , i.e.,
1
(1 )
t t
w w
+
= + and the quantity of human
capital grows at the rateq , i.e.,
1
1
( ) (1 )
T
g T q = + , then
1
1
(1 ) (1 )
T s i s
i s
w w i s T s T q

= + + , = + , , + and
1
1 1
1
1
1
1
1
(1 ) (1 ) 1
(1 )
(1 ) 1
1 1
(1 ) (1 )
1 1
i
T s
s T s T
s i s
i s s
i s T i s T
T T
T
s
r
r w w
r
r
w
r r
r
q

+O
+ +
+O
= + = +
+
O
+ + + | |
+ =
|
+ +
\ .
(
+ + | | | | + +
= .
(
| |
+ +
\ . \ .
(


Therefore,

1
1
1
1 (1 ) (1 ) 1 1
(1 ) 1 1
T T
T
s
s s
r b r
c w
r b r r r
q

+
O
O O
(
+ + + + + | | | |
= .
(
| |
+ + +
\ . \ . (

(11)
From (7), the individual consumption as a function of quantity of human capital reaches maximum when the initial
consumption
s
s
c reaches maximum. Therefore, from (11), we have follow theorem
Theorem 3. If (1 )(1 ) 1 r q + + > + , then the optimal years of schooling is given by

1
1
1
1
1 ln 1
ln(1 )
opt
b
T T
b q
(
= + + .
(
+

(12)
where
1
1 1
ln
r
b
+
+
= .
Proof. Let
( ) ( )
1
1 1
1 1
( ) (1 )
T x
x
r r
h x

q
+
+ +
+ +
(
= +

, then
1
1 1 (1 )(1 )
( ) (1 ) ln(1 ) ln
1 1 1
T x
x
h x
r r r
q
q q
+
(
+ + + + | | | |
' = + + ,
(
| |
+ + +
\ . \ . (


which has a unique zero point
1
1
1
ln(1 ) 1
1 ln 1
b opt
b
T T
q +
( = + +

and the function ( ) h x reaches its minimum at it.
Therefore,
s
s
c has maximum value at the time
1
opt
s T + . This completes the proof of the theorem.
Theorem 4. If (1 )(1 ) (1 ) r q + + > + , then the optimal years of schooling increases when the growth rate of the
quantity of human capital
1
( ) g T increases.
Proof. From (12),
1
(1 )(1 )
1
d
1
d
(1 ) ln(1 ) ln
0
opt
r
T
q q
q q
+ +
+
+ +
= > . The theorem holds.
Lemma 1. Let
| |
1
1 1 1
( ) ln(1 ) ln 1
ln(1 )
b
p b b b q
q
(
= + + + + ,
(
+


then (0) p =0 and
1
( ) 0 p b > for
1
ln(1 ) 0 b q + < < .
Proof. Since (0) 0 p = and
1
ln(1 ) 1
( ) ln 1 0
b
p b
q +
' ( = + <

, the lemma holds.
Theorem 5. If (1 )(1 ) (1 ) r q + + > + and r < , then the optimal years of schooling increases when the wage growth
rate increases.
Proof. From (12) and Lemma 1,
1 1 1 1
2
1 1 1
d d d ( )
0
d d d (1 )[ ln(1 )]
opt
T T b p b
b b b q
= = > .
+ + +

The theorem holds.
5 NUMERICAL SIMULATION
In this section, the structural parameters of the model are given by

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0 1 2 0 065 0 03 60 80 0 64
s
s w r T q = , = . , = . , = . , = , O = , = . .
Under these parameters, the optimal individual years of schooling is
1
22
opt
T = . Figure 1(a) shows the maximal initial
consumption with respect to individual years of schooling and Figure 1(b) presents the optimal individual years of
schooling changes with respect to the parameters and q .
T
1
c
s
s
a
15 20 25 30
1.14
1.15
1.16

T
1
opt
T
1
opt
T
1
opt
b
0.03 0.04 0.05 0.06 0.07
10
20
30
40

FIG. 1 THE OPTIMAL INDIVIDUAL YEARS OF SCHOOLING
Figure 2 presents the individual saving behavior and his asset changes under different years of schooling.
w
s
t
c
s
t
t
T
1
12
T
1
22
T
1
28
a
20 40 60 80
20
10
10
20
30

a
s
t
t
T
1
12
T
1
22
T
1
28
b
20 40 60 80
100
50
50
100

FIG. 2 THE INDIVIDUAL SAVING AND ASSET CHANGE
6 CONCLUSIONS
From Theorem 1 and Theorem 2, we see that the individual optimal consumption and saving behavior is determined
by the individual wage, interest rate and years of schooling. When the wage grows at rate and the quantity of
human capital grows at rate q and satisfies (1 )(1 ) 1 r q + + > + , the optimal individual years of schooling is given
by
1
1
1
1
1 ln 1
ln(1 )
opt
b
T T
b q
(
= + + ,
(
+


where
1
1
1
ln
r
b
+
+
= .
The optimal individual years of schooling increases when the wage growth rate or the quantity of human capital
growth rate increases (Theorem 4 and Theorem 5), which is presented by numerical simulation in Figure 1. The
effect of schooling years on individual saving and consumption behaviors are shown in Figure 2. Comparing Figure
2 with Figure 1 (a), we see that although the individual has higher wage and saving in his working period (the blue
saving curve in Figure 2 (a)), it is not his optimal choice since he must borrow more before he works (the blue asset
curve in Figure 2 (b)). Also long working period is not the individual optimal choice and less years of schooling
implies fewer wages and saving in the working period (The green saving curve in Figure 2 (a)).

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REFERENCES
[1] Modigliani F, and Brumberg R. Utility analysis and the consumption function: an interpretation of cross-section data. In the
collected papers of Fronco Modiglianni, Vol.6, 3-45, The MIT Press, 2005
[2] Modigliani F. Life Cycle, Individual thrift, and the wealth of nations. Science, New Series, Vol. 234, 4777(1986): 704-712
[3] Tobin J. Life Cycle Saving and Balanced Growth. In W. Fellner et al., eds., Ten Economic Studies in the Tradition of Irving
Fisher, New York, 1967
[4] Kwack S. Y., and Lee Y. S. What determines saving rates in Korea? The role of demography. Journal of Asian Economics,
16(2005):861-873
[5] Lau S. Demographic structure and capital accumulation: A quantitative assessment. Journal of Economic Dynamics & Control,
33(2009): 554-567
[6] Kalemli-Ozcan S., Ryder H. E., and Weil D. N. Mortality decline, human capital investment and economic growth. Journal of
development economics, 62(2000):1-23
AUTHORS
Donghan Cai, Male, Han Nationality, PhD, Professor, Current
Research Interests: mathematical economy.
Huan Yang, Femal, Han Nationality, Graduate student.
Zhongbin Chen, Male, Han Nationality, PhD, Associate
Professor, Current Research Interests: Development Economics.