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Imposing Parameter Restrictions for 2 Dynamic "Income Determination" Models
|1.||WHAT RESTRICTIONS MUST BE PLACED UPON THE VALUES OF THE PARAMETER IN ORDER TO ENSURE THAT MODEL 1 IS DYNAMICALLY STABLE?||3|
|2.||WHAT RESTRICTIONS MUST BE PLACED UPON THE VALUES OF THE PARAMETERS IN ORDER TO ENSURE THAT MODEL 2 IS DYNAMICALLY STABLE?||6|
|3.||COMPARE THE LONG-RUN SOLUTIONS OF THE TWO MODELS||8|
Model one is a simplified consumption function with hypothesis for consumption behaviour which means that people use last year’s income as an estimate of expected income.
Stability is the most important notion in economics because it refers to what we call "reality". One is interested in having a stable model, so the model would be easily predictable. Consequences of models without a static equilibrium are that even a small shock may change the model therefore it would restrict forecasting ability of the model. A model is dynamically stable if, following a shock, its variables eventually revert to their equilibrium values. David W. K. Yeung defines dynamic stability or time consistency as the principle solution that must remain optimal at any instance of time.…
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