Contents

Symbols Used XVll

I THE RECURSIVE ApPROACH

1 Introduction 3

2 An Overview 8
2.1 A Deterministic Model of Optimal Growth 9
2.2 A Stochastic Model of Optimal Growth 16
2.3 Competitive Equilibrium Growth 22
2.4 Conclusions and Plans 32

II DETERMINISTIC MODELS

3 Mathematical Preliminaries 39
3.1 Metric Spaces and Normed Vector Spaces 43
3.2 The Contraction Mapping Theorem 49
3.3 The Theorem of the Maximum 55

4 Dynamic Programming under Certainty 66

4.1 The Principle of Optimality 67
4.2 Bounded Returns 77
4.3 Constant Returns to Scale 87
4.4 Unbounded Returns 92
4.5 Euler Equations 97
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5 Applications of Dynamic Programming under Certainty 103
5.1 The One-Sector Model of Optimal Growth 103
5.2 A "Cake-Eating" Problem 105
5.3 Optimal Growth with Linear Utility 105
5.4 Growth with Technical Progress 105
5.5 A Tree-Cutting Problem 107
5.6 Learning by Doing 107
5.7 Human Capital Accumulation 109
5.8 Growth with Human Capital 111
5.9 Investment with Convex Costs 112
5.10 Investment with Constant Returns 113
5.11 Recursive Preferences 114
5.12 Theory of the Consumer with Recursive
Preferences 116
5.13 A Pareto Problem with Recursive Preferences 117
5.14 An (5, S) Inventory Problem 118
5.15 The Inventory Problem in Continuous Time 122
5.16 A Seller with Unknown Demand 123
5.17 A Consumption-Savings Problem 126

6 Deterministic Dynamics 131

6.1 One-Dimensional Examples 133
6.2 Global Stability: Liapounov Functions 139
6.3 Linear Systems and Linear Approximations 143
6.4 Euler Equations 148
6.5 Applications 157

III STOCHASTIC MODELS

7 Measure Theory and Integration 165

7.1 Measurable Spaces 168
7.2 Measures 170
7.3 Measurable Functions 177
7.4 Integration 184
7.5 Product Spaces 195
7.6 The Monotone Class Lemma 199
7.7 Conditional Expectation 202
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8 Markov Processes 210

8.1 Transition Functions 212
8.2 Probability Measures on Spaces of Sequences 220
8.3 Iterated Integrals 225
8.4 Transitions Defined by Stochastic Difference
Equations 234

9 Stochastic Dynamic Programming 239

9.1 The Principle of Optimality 241
9.2 Bounded Returns 259
9.3 Constant Returns to Scale 270
9.4 Unbounded Returns 273
9.5 Stochastic Euler Equations 280
9.6 Policy Functions and Transition Functions 283

10 Applications of Stochastic Dynamic Programming 288

10.1 The One-Sector Model of Optimal Growth 288
10.2 Optimal Growth with Two Capital Goods 290
10.3 Optimal Growth with Many Goods 290
10.4 Industry Investment under Uncertainty 292
10.5 Production and Inventory Accumulation ' 297
10.6 Asset Prices in an Exchange Economy 300
10.7 A Model of Search Unemployment 304
10.8 The Dynamics of the Search Model 308
10.9 Variations on the Search Model 310
10.10 A Model of Job Matching 311
10.11 Job Matching and Unemployment 314

11 Strong Convergence of Markov Processes 316

11.1 Markov Chains 319
11.2 Convergence Concepts for Measures 334
11.3 Characterizations of Strong Convergence 338
11.4 Sufficient Conditions 344

12 Weak Convergence of Markov Processes 352

12.1 Characterizations of Weak Convergence 353
12.2 Distribution Functions 364
12.3 Weak Convergence of Distribution Functions 369
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12.4 Monotone Markov Processes 375

12.5 Dependence of the Invariant Measure on a
Parameter 383
12.6 A Loose End 386

13 Applications of Convergence Results for Markov

Processes 389
13.1 A Discrete-Space (5, S) Inventory Problem 389
13.2 A Continuous-State (5, S) Process 390
13.3 The One-Sector Model of Optimal Growth 391
13.4 Industry Investment under Uncertainty 395
13.5 Equilibrium in a Pure Currency Economy 397
13.6 A Pure Currency Economy with Linear Utility 401
13.7 A Pure Credit Economy with Linear Utility 402
13.8 An Equilibrium Search Economy 404

14 Laws of Large Numbers 414

14.1 Definitions and Preliminaries 416
14.2 A Strong Law for Markov Processes 425

IV COMPETITIVE EQUILIBRIUM

15 Pareto Optima and Competitive Equilibria 441

15.1 Dual Spaces 445
15.2 The First and Second Welfare Theorems 451
15.3 Issues in the Choice of a Commodity Space 458
15.4 Inner Product Representations of Prices 463

16 Applications of Equilibrium Theory 475

16.1 A One-Sector Model of Growth under Certainty 476
16.2 A Many-Sector Model of Stochastic Growth 481
16.3 An Economy with Sustained Growth 485
16.4 Industry Investment under Uncertainty 487
16.5 Truncation: A Generalization 491
16.6 A Peculiar Example 493
16.7 An Economy with Many Consumers 495
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17 Fixed-Point Arguments 501

17.1 An Overlapping-Generations Model 502
17.2 An Application of the Contraction Mapping
Theorem 508
17.3 The Brouwer Fixed-Point Theorem 516
17.4 The Schauder Fixed-Point Theorem 519
17.5 Fixed Points of Monotone Operators 525
17.6 Partially Observed Shocks 531

18 Equilibria in Systems with Distortions 542

18.1 An Indirect Approach 543
18.2 A Local Approach Based on First-Order
Conditions 547
18.3 A Global Approach Based on First-Order
Conditions 554

References 563

Index of Theorems 574

General Index 579

PA RT I

The Recursive Approach