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JIM DOLMAS and MARK A. WYNNE*
Existing analyses of the effects of fiscal policy in general equilibrium models have typically been conducted under the assumption that the long-run supply of capital is perfectly elastic at a fixed rate of time preference. These analyses have shown that the long-run response of the capital stock to changes in fiscal policy is crucial to generating the potential for "multiplier" effects in these models. In this paper we ask, what are the implications of relaxing the assumption of perfectly elastic capital supply for the analysis of fiscal policy? We show that with less than perfectly elastic capital supply, the potential for multipliers is actually enhanced. (JEL E62, D90)
I. INTRODUCTION
Perfectly elastic or perfectly inelastic supply or demand curves have much to recommend them. Equilibrium analysis which would otherwise be fraught with ambiguity yields forth sharp predictions when one assumes either demand or supply are either perfectly elastic or inelastic. Nonetheless, this is not the way we typically teach equilibrium analysis nor, in most circumstances, perform it. Neoclassical macroeconomics is an exception to this rule. Specifically, capital accumulation models in which a representative agent maximizes the standard additively-separable, fixed-discount-factor utility function-to which class most equilibrium business cycle models based on the neoclassical growth model belong-imply a long-run supply curve for capital which is perfectly elastic at the agent's fixed rate of time preference.
This property of what we will refer to as the "standard" model is, and has been, wellknown and well-criticized, even by users of the standard model.1 But, the question of exactly where and when this assumption ceases to be innocuous-i.e., for what sorts of experiments it is or isn't a harmless simplification-has been given surprisingly short shrift.2 In this paper we explore the implications for the equilibrium analysis of the effects of changes in government purchases of relaxing this assumption. In particular, we explore the implications of replacing the fixed discount factor beta in the standard utility specification
where c^sub t^ and l^sub t^ denote consumption and leisure at date t, with an endogenous discount factor, beta(c^sub t^,l^sub t^). In this way, discounting of future utility is allowed to depend on the agent's enjoyment of current consumption and leisure. The lifetime utility function that...