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1 Consumers
Consumers live forever and care about the expected value
E n u(ct+n ),
n=0
ct + at wt .
wt+1 = Rt+1 at .
1
KC Border Lucass Tree Model 2
So ( )
u (ct ) = E u (ct+1 )Rt+1 ,
where c = w a , or
u (ct+1 )
E Rt+1 = 1. (3)
u (ct )
u(c1 ) + u(c2 )
subject to
c1 + a = w
c2 = Ra
or equivalently
1
c1 + c2 = w.
R
The Lagrangean is
( )
1
u(c1 ) + u(c2 ) + w c1 c2
R
and the first order conditions are
u (c1 ) = 0
1
u (c2 ) = 0
R
so rearranging, and dividing the latter by former yields
u (c2 )
R = 1,
u (c1 )
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KC Border Lucass Tree Model 3
wt = (pt + dt )st .
Thus
pt+1 + dt+1
Rt+1 =
pt
and (3) becomes
u (ct+1 ) pt+1 + dt+1
E = 1, (4)
u (ct ) pt
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KC Border Lucass Tree Model 4
4 Market Clearing
In order for the prices to clear the market for trees, then at each t we must
have
st = 1
at = pt
ct = dt .
Special case
If
u(c) = ln c,
(the CobbDouglas case), then u (c) = 1/c and we have
{
}
dt
n
pt = E t dt+n = dt . (6)
n=1
dt+n 1
5 Taxation
In this section we maintain the assumption that u(c) = ln c, and add a
government sector. The governments consumption per capita gt is given by
gt = t dt ,
Tax on trees.
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KC Border Lucass Tree Model 5
ct + at = wt t .
Let pLt denote the equilibrium price of trees at time t under this scheme.
Then ( )
wt = pLt + dt st ,
so
pLt+1 + dt+1
Rt+1 = .
pLt
Market clearing requires that st = 1 and ct = (1 t )dt , so (4) becomes
( )
u (1 t+n )dt+1 pLt+1 + (1 t+1 )dt+1
E ( ) = 1,
u (1 t )dt pLt
so (5) becomes
{ ( ) }
(1 t+n )dt+n
nu
pLt = Et ( ) dt+n .
n=1
u (1 t )dt
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KC Border Lucass Tree Model 6
u (ct+1 ) pT
t+1 + dt+1 t+1
E = 1,
u (ct ) pT
t
So using t = t dt ,
u (ct+1 ) ( T )
pT
t =E p + (dt+1 t+1 ) = 1.
u (ct ) t+1
or using ct = (1 t )dt
{ ( ) }
u (1 t+n )dt+n
pT
t = Et (1 t+n )
n
( ) dt+n .
n=1
u (1 t )dt
5.3 Comparison
Since 0 < t < 1, we have 1/(1 t ) > 1 for each t, so E t 1/(1 t+n ) > 1
for each n, so
1
n Et > n = .
n=1
1 t+n n=1 1
Thus from (7) and (8), we have
pLt > pT
t .
In other words, under a lump sum tax on consumers, the price of trees is
higher than under a tax directly on treeseven though the taxes have no
real effects in this model.
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KC Border Lucass Tree Model 7
References
[1] R. E. Lucas, Jr. 1978. Asset prices in an exchange economy. Economet-
rica 46(6):14291445. www.jstor.org/stable/1913837
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