microeconomics corso e john hey. part 3 - applications chapter 19 – variations. chapters 20, 21...
TRANSCRIPT
MicroeconomicsCorso E
John Hey
Part 3 - Applications
• Chapter 19 – variations.
• Chapters 20, 21 and 22 – intertemporal choice.
• Chapters 23, 24 and 25 – choice under risk.
• Chapter 26 – the labour market.
Intertemporal Choice
• Chapter 20 – the budget constraint.
• Chapter 21 – intertemporal preferences – the Discounted Utility Model.
• Chapter 22 – intertemporal exchange.
A question for you
• An observation: to reduce consumption in an economy, the government usually raises the interest rate. Why?
• If interest rates rise …• … an individual is better or worse off?• … saves more or less?• … spends more or less?• The correct answers?....• … it depends…
When you borrow
Rate of interest
What you borrow in period 1
You must repay in period 2
10% (r=0.1) 100
When you borrow
Rate of interest
What you borrow in period 1
You must repay in period 2
10% (r=0.1) 100 11020% (r=0.2) 100
When you borrow
Rate of interest
What you borrow in period 1
You must repay in period 2
10% (r=0.1) 100 11020% (r=0.2) 100 120
r 100
When you borrow
Rate of interest
What you borrow in period 1
You must repay in period 2
10% (r=0.1) 100 11020% (r=0.2) 100 120
r 100 100(1+r)
r m1
When you borrow
Rate of interest
What you borrow in period 1
You must repay in period 2
10% (r=0.1) 100 11020% (r=0.2) 100 120
r 100 100(1+r)
r m1 m1(1+r)
r m2
When you borrow
Rate of interest
What you borrow in period 1
You must repay in period 2
10% (r=0.1) 100 11020% (r=0.2) 100 120
r 100 100(1+r)
r m1 m1(1+r)
r m2/(1+r) m2
When you save
Rate of interest
Saving in period 1
What you get back in period 2
10% (r=0.1) 100
When you save
Rate of interest
Saving in period 1
What you get back in period 2
10% (r=0.1) 100 11020% (r=0.2) 100
When you save
Rate of interest
Saving in period 1
What you get back in period 2
10% (r=0.1) 100 11020% (r=0.2) 100 120
r 100
When you save
Rate of interest
Saving in period 1
What you get back in period 2
10% (r=0.1) 100 11020% (r=0.2) 100 120
r 100 100(1+r)
r m1
When you save
Rate of interest
Saving in period 1
What you get back in period 2
10% (r=0.1) 100 11020% (r=0.2) 100 120
r 100 100(1+r)
r m1 m1(1+r)
r m2
When you save
Rate of interest
Saving in period 1
What you get back in period 2
10% (r=0.1) 100 11020% (r=0.2) 100 120
r 100 100(1+r)
r m1 m1(1+r)
r m2/(1+r) m2
Chapter 20
• Intertemporal choice.
• Two periods: 1 and 2.
• Notation:
• m1 and m2: incomes in the two periods.
• c1 and c2: consumption in the two periods.
• r: the rate of interest.
• 10% r = 0.1, 20% r = 0.2.
• Hence the rate of return = (1+r)
The Budget Line 1.
• m1 > c1 savings = m1 - c1
• Becomes (m1 - c1)(1+r) in period 2.
• Hence c2 = m2 + (m1 - c1)(1+r).
• Or:
c1(1+r) + c2 = m2 + m1(1+r).
• In the space (c1 ,c2) a line with slope -(1+r).
The Budget Line 2.
• m1 < c1 borrowings = c1 - m1
• Have to repay (c1 - m1)(1+r) in period 2.
• Hence c2 = m2 - (c1 - m1)(1+r).
• Or:
c1(1+r) + c2 = m2 + m1(1+r).
• In the space (c1 ,c2) a line with slope -(1+r).
The Budget Line 3.
• maximum consumption in period 2 =
m1(1+r) + m2
• - this is called the future value of the stream of income.
• maximum consumption in period 1 =
m1 + m2/(1+r)
• - - this is called the present value of the stream of income.
• Note: we say that the market discounts the income in period 2 at the rate r.
The Budget Line 4.
• The intercept on the horizontal axis =
• m1 + m2/(1+r)
– the present value of the stream of income..
• The intercept on the vertical axis =
• m1(1+r) + m2
– the future value of the stream of income...
• The slope = -(1+r)
Generalisation
• If the individual receives a stream of income:
• m1, m2, m3 … mT
• The present value is
• The future value is
t 1
T mt
( )1 r( )t 1
t 1
T
mt ( )1 r( )T t
An imperfect market (10% and 51%)
Chapter 20
• The rest of Chapter 20 uses general preferences. (So you do not need to study the rest of this Chapter.)
• In Chapter 21 we use Discounted Utility Model preferences.
