Consider the Ramsey model:

maxctt=0t=0tu(ct) (1)

subject to

kt+1=f(kt)ct+(1)kt t=0,1,... (2)

Suppose a researcher is unsatisfied with the fact that this version of the model is completely deterministic, and wants to introduce a stochastic/random component to investment. The researcher introduces an investment shock ti by modifying the policy functions as

ct (kt) = (1 )Akti (1)

kt+1(kt) = Akt +ti (2)

Questions:

a) Discuss what happens in this model in response to a temporary shock to investment.

b) What do you think are the main advantages and disadvantages of the approach proposed?

c) Can you discuss (without deriving) a possible alternative way?