Local indeterminacy under dynamic efficiency in a two-sector overlapping generations economy (Q553524): Difference between revisions

This paper presents an overlapping generations economy where agents live two periods. These agents work only in the first period and they split their income between current consumption and savings (investments in firms). The sole source of purchasing power of an agent in the second period of life comes from his/her first period's savings. There is a representative agent for each generation and it is assumed that the agent has a fixed and common-to-all number of descendants -- thus the population of agents grows at a constant rate. The representative agent's utility function is of CES class and the function is parameterized with a normalizing parameter. The production side consists in two sectors: consumption-good and capital-good sector. Each sector has a neoclassical CRS technology. Both sectors are delineated by the profit maximizing representative firms. Labor, capital goods and consumption goods are used in the process of production. The economy of agents and firms evolves over (discrete) time and some standard constraints are imposed for the feasibility of streams of state and decision variables. It is shown that there exists the unique normalized steady state of capital. Moreover, necessary and sufficient conditions for local indeterminacy of the normalized steady state are proved under the assumption of dynamically efficient growth paths of the economy, gross substitutability of consumption and a capital intensive consumption good. This result discriminates the aggregate OLG models from the two-sector model presented in the article. It is also shown that there exists a budget-balanced policy driving the economy toward the properly defined Pareto-optimal steady state (and thus ruling out business cycles). Further, an example of the economy satisfying imposed hypotheses is presented.