3.2 Household and human capital accumulation
The household in the economy has a utility function given by:
c1-τ 1
u (ct) = ct------1 τ > 0
t j 1 - τ
where ct is consumption, and to simplify the analysis we then assume τ = 1, that is:
u (ct)=lnct (7)
The household is then endowed with one unit of time supplied each period,
that is spent on working (the fraction Tts) or on human capital accumulation (the
fraction 1 - Tts), and the accumulation of human capital is described by the following
equation:
ht+ι = Et • h • (1 - /. 0 < δ < 1 (8)
where Et is an efficiency parameter.
The household’s intertemporal optimization program in the decentralized econ-
omy is then given by11:
∞
max βt ln ct
{ct,Tts,at+1,ht+1}t∞=0 t=0
at+1 =(1+rt ) at + wt htTts - ct
s.t.
ht+1 = Ethtδ (1 - Tts)1-δ
where β is the discount factor (with 0 <β<1)andat represents the assets held at
time t.
The Lagrangian for this problem is:
L = X©et ln ct + βtμt [(1 + rt) at + WthtTts - ct - at+i] +
t=0
+βt λt hEthtδ (1 - Tts )1-δ - ht+1 io
11 plus the standard transversality conditions.
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