Notesale: Turn your study into money

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FIRST MODEL:
Galor-Zeira (1993) : The credit market imperfection approach

Production of final good = production agricultural + production manufacturing

Production in the agricultural sector = amount of labour * wage of unskilled worker

Production in manufacturing is a function of human and physical capital
Basically takes wage a constant and given

Individuals:
Over-lapping generation model
A generation of size 1 is born every period and lives for two periods
Each individual has one parent and one child
A young person and an adult form a dynasty
In every period there’s two types of individuals
In their first life period:
Individuals are endowed with a parental bequest & invest in human and/or physical capital
The young don’t work but receive help from their parents
Young make decision in how much to invest in education in t+1
In their second life period:
Individuals supply labour inelastically, consume and bequeath
Adults make a decision: to allocate to consumption or transfer to offspring
u = utility of individual i who is young and born in period t
log c(t+1) = obtains utility from consumption in the future
log b(t+1) = obtains utility from requesting to next generation

Budget constraint: consumption next period + bequest next period
Bequest next period is a function and a fraction of income

To become skilled, there is a fixed cost, h
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If you don’t have money, don’t borrow, because the amount you have to pay back (h*theta*R) is higher than the
increase in wage:
h*theta*R > Ws - Wu
This mechanism generates the poverty trap
Borrowing 100% (full loan) not a good idea, but what about 90%, 80%…?
Implication: There is a threshold level at which it is worth borrowing the rest (0 < x < 100)

So we need to find which of the two (above) is higher, giving you a threshold where an individual will invest in human
capital if and only if b > b^
where b^ = (Wu - Ws + h*theta*R) / [R*(theta - 1)]

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The dynamical system: governs the evolution of bequests over time of a dynasty
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Wealth distribution determines long term outcomes
The economy is the average of its dynasties
We need credit market imperfection (Galor-Zeira, 1993)
Otherwise, if borrowing rate was same as lending rate, everyone would borrow to finance education and phi line
would be flat
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g, you have to graduate:
criticise assumption: education is divisible - you can take 1 or 2 year courses
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In standard production function: you get a little education to gain some return & eventually escape the poverty trap by
increasing level of education of future generations
Utility function is homothetic: a constant fraction Beta of income is passed onto the next generation
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g, winning the lottery)
Adding randomness would kill the result, as probabilities would determine the long-run results
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Tel-Aviv Paper (2012)
Why do poor people do things that don’t help them escape poverty traps?
Idea is that there is a trade-off between conspicuous human capital and income
Research in economic development: people converge back to the bad equilibrium of borrowing even when they pay
lump-sum
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Not necessary to understand TECHNICAL DETAILS, just the STORY



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