Overview

Introduction

The basic Solow model assumes the following:

  • Constant returns to scale production function
  • Constant population growth $n$
  • Constant technological progress $g$
  • Fixed savings rate $s$

Although it is a useful model, the choice of $s$ is arbitrary and does not obey any microeconomic foundation. In particular, microeconomic theory relates present and future consumption decisions through the interest rate. The Ramsey model amends these shortcomings and the decisions of all agents are microeconomically founded. In particular, we assume:

Ramsey assumptions:

  • A large number of identical firms operating with the same technology:
    • Rent capital and hire labour
  • A large number of households:
    • Consume, supply labour, own and lend capital
  • Constant returns to scale production function

Agents (households) optimally decide consumption and savings, depending on the interest rate. Hence, the saving rate is definitely no longer exogenous and need not be constant.

In this course we focus on the discrete-time version of the Ramsey model. In particular, time takes values $t=0,1,\ldots,+\infty.$


References

Ramsey (1928)
Cass (1965)
Koopmans (1965)

Romer, Advanced Macroeconomics: Chapter 21


  1. Romer derives all the results in continuous time, we use discrete time. ↩︎