Intertemporal and Strategic Modelling in Economics: Dynamics and Games for Economic Analysis (Lecture Notes in Economics and Mathematical Systems Book 693)

This textbook introduces readers to essential tools, techniques and methods for intertemporal and strategic modeling in economics. It presents a variety of analytical models covering both dynamic processes and strategic interaction. Students will learn the basic mechanisms associated with the intertemporal approach, on the one hand, and game theory, i.e., the strategic approach, on the other. In addition, a wide range of applications are explored, including growth models, labor markets, international trade, and individual decision-making. Intended for upper undergraduate and graduate students in economics and related fields with a background in mathematics and calculus, this textbook provides a comprehensive introduction to economic modeling and its applications. By avoiding excessive formalism and exploring straightforward examples and applications, it is optimally suited for graduate courses in economics and finance. Preface 6 Contents 8 1 Dynamics: Intertemporal Decision-Making 12 1.1 The Two-Period Budget Constraint 12 1.2 The Intertemporal Budget Constraint 14 1.3 The Utility Function 15 1.4 Time Preference and Intertemporal Utility 16 1.5 The Two-Period Utility Maximization Problem 19 1.6 The Infinite Horizon Utility Maximization Problem 22 1.7 Endogenous Labor Supply 24 1.8 Finite Horizons and Life Cycle Choices 29 1.9 Money and Prices 31 1.10 Decreasing Impatience and Inconsistent Plans 34 1.11 Review Questions 38 2 Games: Strategic Decision-Making 41 2.1 Basic Elements of a Game 41 2.2 Normal Form Games 43 2.3 Dominant Strategies and Nash Equilibrium 43 2.4 Classification of Game Solutions 44 2.5 Examples of Normal Form Two-Player Games 46 2.6 Games with More Than Two Strategies 50 2.7 Mixed Strategies 51 2.8 Games with Incomplete Information 52 2.9 Sequential Games or Games in Extensive Form 52 2.10 Evolutionary Games 56 2.11 Review Questions 59 3 Economic Growth Models 63 3.1 The Neoclassical Production Function 63 3.2 The Profit Maximization Problem of the Representative Firm 66 3.3 Neoclassical Growth with Exogenous Savings (the Solow Model) 67 3.4 Income Convergence 71 3.5 Additional Elements: Population Growth and Labor Productivity 73 3.6 The Ramsey Growth Model 75 3.7 Transitional Dynamics in the Ramsey Growth Model 76 3.8 Growth in Discrete Time 79 3.9 Investment with Adjustment Costs 83 3.10 Overlapping Generations and Growth 87 3.11 Review Questions 90 4 More on Growth Dynamics: Endogenous Growth and Beyond 93 4.1 Endogenous Growth with Exogenous Savings: The AK Model 93 4.2 The AK Model with Transitional Dynamics 95 4.3 Externalities and Endogenous Growth 96 4.4 Human Capital and Endogenous Growth 98 4.5 The Dynamics of the Uzawa–Lucas Model 101 4.6 Technical Progress and Endogenous Growth 103 4.7 A Model of Allocation of Time 106 4.8 Automation and the Fall of the Labor Share 108 4.9 Heterogeneity: Ants and Grasshoppers 112 4.10 Ants and Grasshoppers in an AK Endogenous Growth Model 115 4.11 Review Questions 115 5 The Search and Matching Model 119 5.1 The Matching Function and Labor Market Tightness 119 5.2 Unemployment Dynamics 121 5.3 Optimal Firm’s Behavior 121 5.4 Optimal Worker’s Behavior 123 5.5 Wage Bargaining 124 5.6 Equilibrium and Dynamics 126 5.7 Search Intensity 130 5.8 Endogenous Job Destruction and Endogenous Unemployment Benefit 131 5.9 Heterogeneity 134 5.10 A Goods Market Search and Matching Model 135 5.11 Review Questions 137 6 Fiscal Policy and Government Intervention 140 6.1 The Government Budget Constraint in Two-Periods 140 6.2 The Government Budget Constraint in Multiple Periods 142 6.3 Ricardian Equivalence (Two Periods) 144 6.4 Ricardian Equivalence (Long Horizons) 145 6.5 Tax Systems and Welfare 146 6.6 A Two-Period Model With Multiple Taxes 150 6.7 Social Security 153 6.8 Social Security as Insurance 155 6.9 Unemployment Benefit 156 6.10 A Public Goods Game 159 6.11 Review Questions 160 7 New Keynesian Macro Dynamics 163 7.1 Household Behavior Under Monopolistic Competition 164 7.2 Firm Behavior Under Monopolistic Competition 167 7.3 Macro Equilibrium Without Nominal Rigidities 168 7.4 Price Stickiness 170 7.5 The New Keynesian Is and Phillips Curves 172 7.6 The Dynamics of the New Keynesian Model: Optimal Monetary Policy 174 7.7 The Dynamics of the New Keynesian Model: The Taylor Rule 178 7.8 Information Stickiness 181 7.9 Heterogeneous Agents: Fundamentalists Versus Trend Followers 183 7.10 Heterogenous Agents: Optimizers Versus Hand-to-Mouth Consumers 186 7.11 Review Questions 187 8 International Trade and Geography 190 8.1 A Heterogeneous Productivity Setting 190 8.2 Iceberg Costs and Exports 192 8.3 Imports 194 8.4 Market Dimension, Cost Structure, and Dynamic Gains from Trade 196 8.5 Foreign Direct Investment 199 8.6 Simple Location Dynamics 201 8.7 A Time–Space Equation 206 8.8 An Epidemiological Model of Knowledge Diffusion 207 8.9 Waves of Knowledge Propagation 210 8.10 International Environmental Management 212 8.11 Review Questions 214 9 Additional Applications 217 9.1 The Cobweb Market Model 218 9.2 Allocation of Talent and Economic Growth 220 9.3 Basic Science Versus Applied Technology: Setup 224 9.4 Basic Science Versus Applied Technology: Dynamics 225 9.5 Socially Responsible Investment: Setup 227 9.6 Socially Responsible Investment: Dynamics 229 9.7 Agency Relations in the Brain: Setup 232 9.8 Agency Relations in the Brain: Dynamics 234 9.9 Chaos: A Simple Example 236 9.10 Rock-Paper-Scissors Evolutionary Game 238 9.11 Review Questions 241 Reference List/Suggestions for Further Reading 244 Chapter 1. Dynamics: Intertemporal Decision-Making -- Chapter 2. Games: Strategic Decision-Making -- Chapter 3. Economic Growth Models -- Chapter 4. More on Growth Dynamics: Endogenous Growth and Beyond -- Chapter 5. The Search and Matching Model -- Chapter 6. Fiscal Policy and Government Intervention -- Chapter 7. New Keynesian Macro Dynamics -- Chapter 8. International Trade and Geography -- Chapter 9. Additional Applications