Ec413: Ramsey-Cass-Koopmans growth

by
Danny Quah
E onomi s Department LSE
dq@econ.lse.ac.uk
http://econ.lse.ac.uk/staff/dquah/c/ec413/
September 2009

This do ument des ribes the Ramsey-Cass-Koopmans model (here-

after RCK model), a variant of the neo lassi al growth model that en-
dogenizes the savings and a umulation de ision. The model repla es
an arbitrary if onvenient onstant savings rate with a fully-spe ied
model of optimal onsumption over time.
Many of the riti al predi tions of the original neo lassi al growth
model of interest to us remain invariant to the RCK modi ation.
But, obviously, having onsumption de isions made expli it allows
dis ussion of many ri her situations than before. Generalizations and
variants of the RCK model pervade ma roe onomi s, sometimes in
situations quite remote from neo lassi al growth.
The new riti al te hni al points in this note are the rst-order
onditions (2.5) and (2.6). The Te hni al Appendix Se tion 3 is a
self- ontained, informal dis ussion of their derivation.

1 Notation and assumptions

Re all the per apita notation for output or in ome, y = Y =N , with
the te hnology-adjusted version, y~ = y=A. Similarly, k and k~ are,
respe tively, the per apita and the te hnology-adjusted per apita
apital sto ks. Now, dene also = C=N and ~ = =A for the orre-
sponding versions of onsumption.
Time is ontinuous and pro eeds on t 2 [0; 1. The timepath
for onsumption , say, is denoted f (t) : t 2 [0; 1g, and similarly
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for in ome y and the apital sto k k. The model will determine
timepaths for , y, and k, among other variables of interest.
The population at time t is N (t). Assume agents in the e onomy
are identi al and innitely-lived, and that population grows as
N (t) = N (0)e t () N_ =N = :

1.1 Preferences
At time t the representative agent enjoys utility ow derived from
onsumption

U ( (t)) = U (~ (t)A(t)); U 0 > 0; U 00 < 0:

Although not essential to the dis ussion, it will be onvenient below

to onsider utility fun tions that show onstant relative risk aversion
(CRRA), i.e., where
def U 00 ( )
R( ) = > 0
U 0 ( )

is onstant. (In a sto hasti environment R would be the oe ient of

relative risk aversion. Here, the model does not onsider un ertainty
but the terminology is already familiar and therefore useful.)
The agent dis ounts the future at rate  > 0, so that lifetime
utility, looking forwards at time 0, has the present dis ounted value
form: Z 1 Z 1

e t
U ( (t)) dt = e  t U (~
(t)A(t)) dt:
0 0

Adding up a ross the N (t) agents in so iety at ea h time t gives

welfare for so iety at t = 0 as
Z 1
e t
U (~
(t)A(t))  N (t) dt
0
Z 1
= N (0)  e ( ) t
U (~
(t)A(t)) dt:
0

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Noti e that so ial welfare entails forward-looking elements from both

population hanges and agents' anti ipating their future onsumption
timepath.

1.2 Technology
Suppose output is given by a onstant returns to s ale produ tion
fun tion with labour-augmenting te hnology:

Y = F (K; N A) =) y~ = F (k;
~ 1) def
= f (k~):
Let the produ tion fun tion F imply:
~)
f (k ~)
f (k
lim ~ = +1 and lim ~ = 0:
~ !0
k k ~ !1
k k

The rst of these states that the marginal produ t of apital is arbi-
trarily large at small enough values of the apital sto k. The se ond
states that the average produ t of apital eventually gets arbitrarily
small for large values of the apital sto k.
Assume te hnology grows at onstant rate  , i.e.,

A(t) = A(0)e t () _
A=A = :

Capital depre iates at onstant rate and a umulates from savings,

i.e.,
_
K =Y C K =) k~_ = f (k~) ~ ~;
k where  = +  +  .

Assume the initial sto k of apital K (0) is positive and exogenously

given.
Finally, assume  > 0; obviously su ient for this would be all of
,  , and  non-negative with at least one of them positive.

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2 Competitive equilibrium  social planner

We won't need to draw on this further but de entralized ompetitive
equilibrium in this e onomy is a so ial optimum. That equilibrium
allo ation an then be re overed by solving the appropriate so ial
planning problem:
Z 1

max e (  )t U (~
(t)A(t)) dt
f ~; k~g 0
s.t. k~_ (t) = f (k~(t)) ~(t)  k~ (t) (2.1)
given k~(0) > 0
lim k~(t) = 0 (2.2)
t!1
~(t)  0 8t  0:
k (2.3)
The notation is suggestive: This problem entails maximization over
entire timepaths of ~ and k~, not just over s alars ~(t) and k~(t) at a
given time t. Equation (2.1) is the transition equation for the apital
sto k. Condition (2.2) is a transversality ondition that disallows the
apital sto k to be arbitrarily large in the innite future. It would
hardly ever be sensible to do that|people should just onsume the
apital instead|but it's useful te hni ally to make this expli it. Sim-
ilarly, ondition (2.3) asserts the apital sto k an never go negative.
Impli it in the statement of the problem is also that while the
timepath for ~ an be relatively arbitrary|for instan e, it might in-
volve jumps or dis ontinuities|that for k~, from equation (2.1), has
to be dierentiable, and therefore ontinuous. [If you were to draw
the timepath of k~ with pen il on paper, the pen il must not be lifted
o the page.

2.1 Hamiltonians
A onvenient way to solve the kind of problem given in Se tion 2 is to
use Hamiltonians : these are the dynami ounterpart of Lagrangeans.

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Denote a Lagrange multiplier timepath f (t) : t 2 [0; 1 g and

dene the Hamiltonian fun tion:

H(~ ; k~; ; t) = U (~ (t)A(t)) e

def ( ) t
h i
+ ~ (t))
f (k ~(t) ~(t) (t) e
k ( ) t
: (2.4)
Noti e how the Hamiltonian H diers from a Lagrangean. The rst
term on the right side of (2.4) is not the obje tive fun tion but in-
stead just the time t pie e of it. The se ond term is the Lagrange
multiplier (t) multiplied by a non-negative term and k~_ . (In some
formulations the non-negative exponential term is absorbed into the
Lagrange multiplier itself|the dieren e is unimportant, as long as
usage remains onsistent. See, however, the dis ussion in Se tion 3
for why I hoose to do things this way.)
The onditions that hara terize solution to the original problem
of Se tion 2 turn out to be des ribed by the mu h simpler:
 H= ~(t) = 0 (2.5)
h i
d
 H= k~(t) = dt
(t)e ( ) t
(2.6)
The derivation is not on eptually di ult but takes us too far out
of our way [see, however, the Te hni al Appendix, Se tion 3.
Equation (2.5) is the rst-order ondition that applies to the de i-
sion variable whose timepaths an be dis ontinuous, i.e., the value for
~(t) an be adjusted to be optimal instant-by-instant through time.
The equation states ~(t) should vary every instant, however is needed,
to zero out its partial derivative in the Hamiltonian.
Equation (2.6) is the rst-order ondition that applies to the de-
ision variable whose timepaths need to be dierentiable. The value
of k~ (t) annot be arbitrarily re-set as it an only vary in a dier-
entiable way from the pre eding timepath f k~(s) : s 2 [0; t) g. So,
instead, equation (2.6) sets the partial derivative of the Hamiltonian
with respe t to su h a smoothly-varying variable to the negative of
the time-derivative of the dis ounted Lagrangean.

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Applying equations (2.5) and (2.6) to the Hamiltonian (2.4) gives:

A U 0 (~
A) = (2.7)
f 0 (k
~)  = ( ) _
= (2.8)
and k~_ = f (k~ ) ~ ~
k (2.9)

where the last simply repeats the equation for apital a umulation.
Equations (2.7){(2.9) provide three dynami equations that will allow
us to solve for timepaths in (~ ; k~; ) simultaneously.

2.2 Balanced growth steady state

Taking the hint from the original neo lassi al growth model dene
BGSS (balan ed growth steady state) by

y~_ = ~_ = k
~ _ = 0:

Below we will see that BGSS equilibrium does exist, and usefully
des ribes the long-run dynami s of the model. For now, however,
just onsider its onsequen es.
BGSS gives
_ = =
y=y _ =  = A=A;
_ = k=k _
i.e., per apita in ome, onsumption, and apital grow at the same
rate, equal that of te hni al progress. Thus, we onje ture and will
verify that the long-run dynami s of the RCK modi ation are iden-
ti al to that of the basi neo lassi al growth model.
In BGSS, unless utility U ( ) = log( ), the Lagrange multiplier
 timepath ontinues to vary even in steady state. Log-dierentiate
with respe t to time both sides of equation (2.7):
 
~_ = ~ +  =  _
= R(~
A) 1
(2.10)
U 00 ( )
where R( ) = > 0:
U 0 ( )

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If utility is logarithmi then R = 1 so that equation (2.10) ol-

lapses to ~_= ~ = =_ , whi h implies  too will then be onstant in
BGSS. In general, however, this will not be the ase, so that steady
state will have  ontinuing to evolve.
To get some intuition for why BGSS is sensible, onsider equa-
tion (2.9). Suppose k~_ =k~ were onstant but not zero in the long run. If
~_ k~ were positive, k~ would get arbitrarily large. But then [f (k~ ) ~=k~
k=
would get arbitraily small, so that the right side of equation (2.9)
would eventually be ome negative, ontradi ting the initial hypothe-
sis that k~_ =k~ remained positive. The same argument, reversing signs,
ontradi ts k~_ =k~ being negative in long run steady state.

2.3 Dynamics
A omplete solution to (2.7){(2.9) in the general ase is neither easily
obtained nor parti ularly insightful. Therefore, impose the additional
assumption that utility is CRRA, i.e.,
R(~
A) = R > 0:

Equation (2.7) allows immediately inferring the behavior of  from

knowledge of ~, and vi e versa. Therefore, we an restri t analysis to
either the pair (; k~) or (~ ; k~). Here, I hoose the latter.
Represent the dynami s of the system
~
k
_ = f (k~ ) ~  k~
h i
~_ = ~ = f 0 (k ~) ( +  + R ) R 1

in the two-dimensional state spa e (~ ; k~) in Figure 2-1.

The two steady-state lo i ~_ = 0 and k~_ = 0 interse t at spe i
values k~ and ~ . These are the values of k~ = k=A and ~ = =A
asso iated with BGSS. The rst steady-state lo us ~_ = 0 an be
solved|as indi ated in the Figure|to give k~ .

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~; ~) dynami s: Ramsey-Cass-Koopmans saddlepath onver-

Fig. 2-1 (k
gen e
~

_ =0
~
k
or ~ = f (k~ ) ~
k

~
k
~_ = 0
or ~ f 0 (k~ )
k 3 = +  + R > 0

Figure (2-1) also indi ates transition dynami s. For any given
initial apital sto k k~(0), not all values of ~(0) will allow the system
of equations to onverge to BGSS (k~ ; ~ ). Instead, for ea h possi-
ble k~(0) > 0 only that unique ~ value on the saddlepath lo us|the
darkened negatively-sloped urve in the Figure|implies (stable) on-
vergen e.
There is of ourse no reason why an initial ~(0) should fall on
the saddlepath. Hen e, for onvergen e the system shows jumps in
~ onto the saddlepath for onvergen e to steady state. Viewed by
an outside observer, however, the behavior of output and the apital
sto k resemble exa tly those of the basi neo lassi al growth model
previously studied.

3 Technical Appendix
This appendix derives the rst-order onditions (2.5) and (2.6) for the
Hamiltonian to des ribe optimization of the original dynami so ial

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planning problem of Se tion 2.

To get at the essentials, set N (t) = A(t) = 1 throughout this
se tion so that  =  = 0 and k~ = k and ~ = .
Then for the original problem the Lagrangean is
Z 1

L = U ( (t))e t dt
0
Z 1h i
k_ (t) f (k(t)) + (t) (t)e t dt:
0

The rst term on the right in L is the original obje tive fun tion.
The se ond term is the integrating up of ea h one of the onstraints
multiplied by its orresponding Lagrange multiplier. Sin e we have
judi iously hosen the true Lagrange multipliers in this expression to
ontain the exponential e t we an rewrite the expression as:
Z 1h   i
L= U ( (t)) k_ (t) f (k(t)) + (t) (t) e t dt:
0

Using the Hamiltonian fun tion

H( ; k; ; t) = ( U ( ) + [f (k)  ) e t

dened previously, rearrange the Lagrangean to be:

Z 1h i
L= H( (t); k(t); t) k_ (t)(t)e t dt:
0

(This is just a he k to onrm that we have written down the orre t

Lagrangean expression.)
Dierentiate the Lagrangean L with respe t to (t), for ea h t,
and set that to zero. Verify by dire t al ulation that that's the same
as H= (t) = 0.
Now turn to the more di ult optimization over dierentiable
timepaths for the apital sto k. Fix a andidate timepath k. Let the
real number   0 and the timepath f x(t) : t  0 g together generate
the perturbation
k(x;) (t) = k(t) + x(t)  ;
def
t 2 [0; 1)
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about k. Consider timepaths k(x;) onstru ted in this way but that
also satisfy onditions (2.1){(2.3), i.e., that are feasible. Thus, if  >
0, say, then we must have at least x(0) = 0 and limt!1 x(t) = 0 for
k(x;) to remain feasible. Noti e that if the initially-given f k(t) : t 
0 g is optimal then we must have  L= = 0 at  = 0 for all x,
provided k(x;) remains feasible.
Now dene the integrand in L by
M(k; k_ ; ; ; t) = H( ; k; ; t) _
ke t
:

Ignoring inessential elements, the Lagrangean evaluated at k(x;)

is Z 1  
L = M k(t) + x(t); k_ (t) + x_ (t) dt:
0

For k to have been optimal, we must have

L
Z 1

=

M dt = 0 at  = 0.
 0

Write M1 =  M=k and M2 =  M= k_ . Then this zero at  = 0 is

Z 1

[ M1 x + M2 x_ dt = 0:
0

But the se ond of these satises

Z 1 1 Z 1 d


M2 x_ dt = M2 x M

2 x dt
0 0 0 dt

(by the produ t rule in al ulus). Provided that jM2 j = (t)e t

remains bounded, then

1

lim x(t) = lim x(t) = 0 =) M2 x = 0:



t!1 t!0
0

Therefore,
Z 1 Z 1 
d
[ M1 x + M2 x_ dt = M 1 M 2 x(t) dt:
0 0 dt

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That this integral equals 0 does not of ourse imply that the integrand
must identi ally vanish. However, sin e x an be arbitrarily hosen
subje t to non-negativity and the two endpoint onditions, we an
on lude from the integral's vanishing that the integrand must vanish
pointwise as well, i.e.,
" #

M =
d
M or
 M =
d  M
k(t)  k_ (t)
1 2
dt dt

at the optimum. But in the original notation this rst-order ondition

is just
H d h i
= (t)e t :
k(t) dt

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