Intertemporal elasticity of substitution and the transitional dynamics and steady state of wealth distribution

Masakazu Emoto and Tamotsu Nakamura
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Masakazu Emoto: Graduate School of Economics, Kobe University
Tamotsu Nakamura: Graduate School of Economics, Kobe University

No 2101, Discussion Papers from Graduate School of Economics, Kobe University

Abstract: Although the steady state equilibrium is represented by a single point in the capital-consumption plane in the standard Ramsey model, it is by a straight line in a Ramsey model with heterogeneous individuals. Taking advantage of this fact, this paper applies the backward induction method to analyze the transitional dynamics of the Ramsey model with heterogeneous individuals, and examines the role of heterogeneity in intertemporal elasticity of substitution (IES). When no heterogeneity exists in IES across individuals, then the wealth Gini declines as capital accumulates, while the wealth gap expands. In contrast, with heterogeneity, various dynamics of wealth distribution can emerge, including a U-shaped relationship between income and inequality. It is also shown that an inverted U-shaped relationship, i.e., the Kuznets curve can be explained by Stone-Geary preferences, which allow IES to change with wealth.

Pages: 26 pages
Date: 2021-01
New Economics Papers: this item is included in nep-dge
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