Macroeconomics I (Neoclassical Growth Models)

This course introduces you to neoclassical growth models, and in doing so it serves as the link between the general equilibrium theory you studied in Microeconomics I and macroeconomics.

Neoclassical growth models are basic models of the evolution of aggregate economic activity over time which build on general equilibrium theory. Standard consumer and producer theory is used to model the behavior of households and firms. Markets are perfectly competitive and complete in these models, and typically bring about an efficient allocation of resources. In this sense there are no frictions or market failures. This class of models has served as a starting point for macroeconomists to think about a large variety of issues, including business cycles, growth, inequality, and asset pricing.

These models are useful for three related reasons. First, they are useful in understanding the efficient allocation of resources in a particular situation, which is a useful benchmark. Second, the nature of discrepancies between the efficient allocation of resources implied by the model and observations of what is going on in the real world can help to determine what type of frictions ought to be included in the model in the context of a particular application. Third, as one introduces frictions into the model to study a particular application, typically various elements of the neoclassical growth model are retained, so they remain important building blocks in the modeling toolbox of macroeconomists.

For example, so-called Dynamic Stochastic General Equilibrium (DSGE) models are a class of models that is widely used to study monetary and fiscal policy, and they are constructed by introducing a variety of frictions into basic neoclassical growth models. In Problem Set 2 we examine to what extent elements of the neoclassical growth models are used in frontier research on macroeconomic issues that you consider most important.

The course starts where Microeconomics I left off. We continue the study of general equilibrium theory, with a focus on making it operational for analyzing the evolution of aggregate economic activity over time. Specifically, we will consider aggregation, dynamics, and uncertainty. Having covered these basics, we will study different versions of the neoclassical growth model, specifically a version with infinitely-lived households and a version with overlapping generations of finitely-lived households. To study quantitative implications one needs to solve the models numerically. As a first step in this direction, you will practice solving the neoclassical growth model using dynamic programming.

Similar to Microeconomics I, this is a first and foremost a theory course. We will use these models to take a first pass at some applications. Applications are drawn from business cycles, growth, inequality, and asset pricing. The purpose of the applications is primarily to promote the understanding of the theory, rather than provide state-of-the-art answers to applied questions.