Basic Models

Abstract

This chapter presents the basic Ramsey model, which is fundamental for modern macroeconomic research and paves the way for the algorithms presented in subsequent chapters. The solution is characterized along two lines: 1) The Euler equations provide a set of nonlinear difference equations that determine the optimal time path of consumption. 2) Dynamic programming seeks a policy function that relates the agent’s choice of current consumption to his or her stock of capital. In the benchmark business cycle model with endogenous labor, stochastic productivity, and growth, Heer and Maußner study the problems of parameter choice and model evaluation. The chapter concludes with a synopsis of the numerical solution techniques presented in Chapters 2 through 7 and introduces measures for evaluating the approximate solutions’ goodness of fit.