I have following dynamic optimization problem

$$V(k_0)=\max \sum_{t=0}^{\infty} b^t((1-a)ln c_t+a ln(l_t))$$

Subject to $l_t+e_t=h$ and $y=Ak_t^pe_t^{1-p}$ and $k_{t+1}=i_t+(1-x)k_t$

Where c is consumption, i is inverse,ent, y is output, k is phisical capital per capita. $l$ is leisure time , e is working time. V is value function. x is depreciation rate. A is total factor productivity.

The question I asked to you is that when a is zero, the economy would accumulate more physical capital? Or not? If yes, Why?

I think that

Capital accumulates according to $k_{t+1}=i_t+(1-x)k_t$

Since investment $i_t=y_t-c_t$



When a=0, the utility function becomes $u(c_t)=ln(c_t)$

That, househoulds get more utility from consumption with this new utility function in comparision to the previous utility function given. So consumption level increases, which decreases one period forward capital stock.

But the things that I said seems to be wrong to some extent. What do you think ? Do you have any other wise idea about this?

  • $\begingroup$ The reason why the model is written in mathematical terms is in order to be able to obtain definite answers on such interesting questions. Certainly an initial assessment and tentative answer is a valuable start - but you will find the answer if you solve the model under the two different assumptions. $\endgroup$ May 25 '18 at 13:49
  • $\begingroup$ I solved the model in two ways by using guess verify method and also by Euler equation. But this question is the first part of the question. So I guess its answer is required without any such long solutions. @AlecosPapadopoulos $\endgroup$
    – mnm123
    May 25 '18 at 21:46

$a=0$ means implies the household does not enjoy leisure. In other words, the trade-off between consumption and leisure is switched off. It's not generally true that with $a=0$, utility is higher for a given value of $c_t$, as this depends on the previous value of $l$. Whether or not consumption rises as a consequence depends also on the parameter $b$, i.e. the utility discount factor. If the household does not value leisure, he might work 80 hours per week and obtain a higher income. If he is very forward-looking however, he might also save a lot for later consumption.


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