Question

Explain how an augmented Ramsey growth model can be used to generate an artificial economic cycle.  Discuss the economic mechanism though which the cycle occurs, and how closely the artificial cycle corresponds to the main facts of a typical real world cycle.

Answer 1

Ramseys model is a neo-classical model that aims at explaining long-run of growth of economy rather than business cycle fluctuations, and excludes any sources of disturbances like market imperfections, exogenous shocks, or heterogeneity among households. The rate of saving rate may not be constant along the transition to the long run steady state. Another implication of the model is that the Pareto efficient outcome. There Ramsey model have are two key equations. The first is the law of motion for accumulation of capital; and second equation concerns the households saving behaviour and is less intuitive. If households maximize the consumption inter-temporally, then at every point in time they equate the marginal gain of consumption today with that of future consumption, or equivalently, the marginal gain of future consumption with its marginal cost.