Static Economy Functional Forms

Competitive Equilibrium Approach

Logarithmic Utility Functional Form

( ) u , ln ln c l c l = +
( ) s.t. 1 c w l rk = +

Goal: ( ) maxln 1 ln
l
w l rk l + + (



F.O.C. w.r.t. l : Take the derivative with respect to l and then solve for l
*
.

( )
( )
*
1 1
( ) 0
1
1
2
)
2
1
1
(
w
w l rk l
w
w l rk l
wl w wl rk
wl w rk
w rk
l
w
+ =
+
=
+
= +
= +
+
=


So we found our l
*
, but this expression is not in terms of the primitives of the problem:
( ) , , 1 z t o = . We need to somehow get it in terms of these primitives.

From the firms problem we have:

1
y zk n
o o
=

And so:

( )
1 1
and
1
y
r z k n
k
y
w z k n
n
o o
o o
o
o

c
= =
c
c
= =
c


Therefore,
1 1
(2)
1 1 1
r k n n
w k
o o o o
o o
o o
+
= =



We now substitute (2)into (1) using 1 n l = :

( )
( )
*
1 1
2 2 2 2 1
1 1
2 1 2 2 1
1
1 1
2 1 2 1
2 2 1
1
2 1 2 1
1
.
2
w rk k l
l
w w k
k l k
l
k k
l
l
l
o
o
o o
o o
o o
o o
o o o
o o
o

= + = +

+ = +

(
(
+ = +
(
(



+ (
= +
(


=

So we have succeeded in getting it in terms of the primitives!

Note: log utility functions are independent of increases in z or w. Why?

Quadratic (like) Utility Functional Form

( )
2 2
1
u ,
2
t t
A
c l Ac c l = +
( ) s.t. 1 c w l rk = +

Goal:
2 2
1
max
2
t t
l
A
Ac c l +

(Quick way to do it:
( )
2
1 1 1 2
,
u 2 .
2
t t
u c l A
A c A A c
c
c
= = =
c


F.O.C. w.r.t. l : (solve for l
*
)

( )
( ) ( )
( ) ( )
1 2
2 1
2
2 2 1
1 ( ) 1 0
1 1
1 (1) 1
A A w l rk w
A w w l rk A
A w l A wrk A
+ + = (

+ = + (

+ = +


From the firms problem, we already know:

( )
( ) ( )
1
1
1
and
1 1
(2)
( ) 3
y
r z k l
k
y
w z k l
n
o
o
o
o
o
o

c
= =
c
c
= =
c

(This is the same as from the logarithmic form)

Substituting (2) and(3) in(1) , we now simplify and solve for l
*
:

( ) ( ) ( ) ( ) ( ) ( ) ( )
( ) ( ) ( ) ( ) ( )
( ) ( ) ( ) ( ) ( )
( ) ( )
( )
2 2 1
2 2 2 1
2 2 1
2 1 2 1
2 2 2 1 1
2 2 1
2 1 2 1 2
2 2 2 2
2 2 1
1 2
2 2 2 2
2 1
1
1 1 1 1 1 1 1
1 1 1 1 1
1 1 1 1 1
1 1 2 1
1
A l z k l A k z k l k l A
A z k l A z k l A
A z k l A z k l A
A z k l A
l
o o o
o o o
o o o
o o o
o o
o o
o
o
o o o
o o o
o o o
o o o o

+
+ +

(
+ = +

+ = +
+ = +
( + + = +

( )
( )
( )
( )
( )
( )
2
1
2 2
2
1
1 2
1
2 2
2
1
1 2
1 *
2 2
2
1
1
1
1
1
1
(4)
1
1
A
A z k
A
l
A z k
A
l
A z k
o
o
o
o
o
o
o
o
o

+
=

( +
=
(


( +
=
(


Comparative Statics

If z (technology constant) increases/decreases, would the representative agent increase/decrease
leisure? Or would the agent not change leisure at all?

To find out, we take the partial derivative of (4) (l
*
) with respect to z:

We need to apply the chain rule here. So we take the derivative of the outside evaluated at the
original inside stuff and then multiply by the derivate of the inside stuff. First we use the power
rule to get:

( )
( )
1
1
1 2
1
2 2
2
1
1
1 2 1
A
l
z A z k
o
o
o o

( +
c
=
(
c



Now we need to use the quotient rule to get the derivative of the inside:

Using:
2
du
dz
u
d
v
dz v
z
v u
dv
d

= . (I color coded the parts to make it easier to see whats going on.)

( )
( )
( ) ( ) ( ) ( ) ( )
( ) ( )
( )
( )
( ) ( )
( ) ( )
( )
( )
1
1
1 2
1
2 2 2
2 2
2
2
1 1 2
2
1 2
1 1 2
2 2 2
2 2
2
2
2
1 2
1
2 2
2 2
2
2
1
2
2
1
1
1 2 1
1
1 1 1 2
1
1 2
0
1
1
1
1 2
1
1 1
1
2 1
A
l
z A z k
A z k
A A A
A z k
k
A z k
z
A z k
A z
A z
A
k
A
k
o
o
o
o
o
o
o
o
o
o
o
o
o o
o
o
o o
o
o
o
o
o

(
( +
c
(
=
(
( c


( + +
=
(


( +
=

+
( ) ( )
( ) ( )
2
1 2
2
2 2
2
1 1 2
.
1
A A k z
A z k
o
o
o
o
o
+

Analysis:

- We need to look at each piece of the above derivative to determine the overall sign.
- We assumed that A
1
and A
2
are positive constants.
- <1 we know we have constant returns to scale in a Cobb-Douglas production
function.

1. First we will look at the third part of the derivative.

( )
( )
( ) ( )
( ) ( )
2
1 2
2
2 2
2
2
1 2
1
2 2
2
1
1
.
1 2
1 1 2
1
1
A
l
z A z k
A A k z
A z k
o
o
o
o
o
o
o o
o

+ (

+
c
=
(



c


It is fairly easy to see that everything in the third part will be positive based on our
assumptions about , A
1
and A
2
.

2. Next we will look at the second part of the derivative.

( )
( )
( ) ( )
( ) ( )
2
1 2
2
2 2
2
2
1 2
1
2 2
2
1 1 2
1
.
1 2
1
1
1
A
A z k
A A k z
l
z
A z k
o
o
o
o
o
o
o o
o

+ (
c
=
c

+
(

We notice that there is a negative sign inside the brackets. However, if the exponent
2
1 2
o
o
turns out to be an even number greater than 1, then the second part will be
positive. For example, if the exponent turns out to be 2 after you plug in for , we will
just square the term and it becomes positive. We will assume that this is true for the
rest of the analysis.

3. So, the only part of the derivative that could change the sign is the first part:
1
1 2o

. We
can look at two possibilities for this part of the derivative.
i. If ( ) 1 2 0, o > then we know
1
.
2
o < So we have a negative times a positive, and
thus 0.
l
z
c
<
c
(Work it out on paper.) This means that as the technology constant z
increases, leisure will decrease. Similarly, as z decreases, leisure will increase.
ii. If ( ) 1 2 0, o < then we know
1
.
2
o > Now we have a negative times a negative, and
thus 0.
l
z
c
>
c
In this case, as z increase, leisure also increases.


2
** For 1
1 2
2 1 2
4 1
1
.
4
o
o
o o
o
o
>

>
>
>


The value of is usually between
1
2
and
2
3
based on empirical research.