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A Note on the Euler Equation of the Growth Model

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  • Li, defu
  • Bental, Benjamin

Abstract

The neoclassical Euler equation provides the necessary conditions for households to maximize lifetime utility by allocating income between consumption and investment, and is the core equation for solving the steady-state of the neoclassical growth model. The existing textbooks (Barro and Sala-i-Martin, 2004, ch6.3; Acemoglu, 2009, ch13.2, ch15.6; Aghion and Howitt, 2009, ch3.2.2) ignore the premise of this equation and directly apply it to solve the steady state of other growth models, which not only leads to incorrect results but also limits the ability of growth models to analyze the steady-state technological progress direction. This note first points out and rigorously verifies the errors in existing textbooks; Then, by replacing the capital accumulation function with exogenous growth rate with the generalized capital accumulation function considering adjustment costs of investment in the Acemoglu (2009, ch15.6) model, the note put forward the generalized Euler equation and steady-state equilibrium including capital-augmenting technological progress, which reveals the necessary conditions for the neoclassical Euler equation and Uzawa’s (1961) steady-state theorem; Finally, it is pointed out that the possible reasons for the misuse of the neoclassical Euler equation in existing textbooks maybe confuse the rental price of capital and the interest rate of investment.

Suggested Citation

  • Li, defu & Bental, Benjamin, 2023. "A Note on the Euler Equation of the Growth Model," MPRA Paper 119048, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:119048
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    References listed on IDEAS

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    1. Robert M. Solow, 1956. "A Contribution to the Theory of Economic Growth," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 70(1), pages 65-94.
    2. Francisco L. Rivera-Batiz & Luis A. Rivera-Batiz, 2018. "Economic Integration and Endogenous Growth," World Scientific Book Chapters, in: Francisco L Rivera-Batiz & Luis A Rivera-Batiz (ed.), International Trade, Capital Flows and Economic Development, chapter 1, pages 3-32, World Scientific Publishing Co. Pte. Ltd..
    3. H. Uzawa, 1961. "Neutral Inventions and the Stability of Growth Equilibrium," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 28(2), pages 117-124.
    4. Daron Acemoglu, 2003. "Labor- And Capital-Augmenting Technical Change," Journal of the European Economic Association, MIT Press, vol. 1(1), pages 1-37, March.
    5. David Cass, 1965. "Optimum Growth in an Aggregative Model of Capital Accumulation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 32(3), pages 233-240.
    6. Nicholas Kaldor, 1961. "Capital Accumulation and Economic Growth," International Economic Association Series, in: D. C. Hague (ed.), The Theory of Capital, chapter 0, pages 177-222, Palgrave Macmillan.
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    More about this item

    Keywords

    Neoclassical Euler equation; Uzawa’s steady-state theorem; Growth model; the direction of technical change，the rental price of capital; the interest rate of investment;
    All these keywords.

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • O30 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - General
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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