GOVERNMENT BONDS The model can be closed, as in Diamond(1965, pp. 1130-35), b specifying a constant-returns-to-scale production function that depend of capital and labor the products of capital and labor to r and w, respectively. The value of r for the current period would then be determined in order to equate the supply of assets to the demand-that is K where K(r, w) is such as to equate the marginal product of capital to r The current demand for assets, A1+ A,, depends, from equations (5 and(6), on r, w, and the previous periods value of K, which is equal to A1+ Ao. Since the number of people in each generation is assumed to equal a fixed number N, it is not necessary to enter this number explicitly into the aggregate asset demand in equation (7). Similarly, N is omitted from the aggregate formulations below. Since N is constant and technical change is not considered, the current and previous periods'values of K would be equal in a steady state With the marginal product of labor equated to we and with constant returns to scale, output is given by y=rk+w Equations(2),(3),(7), and(8) imply a commodity market clearing where Ak denotes the change in capital stock from the previous to the current period. The value of AK would be zero in a steady state, but the present analysis is not restricted to steady-state situations Suppose now that the government issues an amount of debt, B, which can be thought of as taking the form of one-period, real-valued bonds. These bonds pay the specified amount of real interest, rB, in the current period and the specified real principal, B, in the next period. It supposed that asset holders regard equity and government bonds perfect substitutes. It can be assumed, for simplicity, that the government bond issue takes the form of a helicopter drop to currently old (generation 1)households. Equivalently, it could be assumed that the bonds were sold on a competitive capital market, with the proceeds from this sale used to effect a lump-sum transfer payment to generation I households amount of bond issue would be limited by the government's collateral, in the ense of its taxing capacity to finance the interest and principal payments(see n. 12