Topic 1 Lecture 10
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Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Applications of Consumer Choice Theory 2. Inter-temporal Choice I 1 , C 1 I 0 , C 0 Think of an ‘Endowment Point’ and add it to the diagram. 1
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Topic 1 Lecture 10. Applications of Consumer Choice Theory 2.Inter-temporal Choice. Think of an ‘Endowment Point’ and add it to the diagram. I 1 , C 1. I 0 , C 0. Topic 1 Lecture 10. Inter-temporal Choice. From the Endowment Point, where can Saving take you? (And then Borrowing?). - PowerPoint PPT Presentation
Transcript of Topic 1 Lecture 10
Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Applications of Consumer Choice Theory2. Inter-temporal Choice
I1 , C1
I0 , C0
Think of an ‘Endowment Point’ and add it to the diagram.
1
Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
From the Endowment Point, where can Saving take you?
(And then Borrowing?)
E
I0
I1
2
Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
From the Endowment Point, where can Saving take you?
E
I0
I1
3
Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
From the Endowment Point, where can Saving take you?
E
One Euro saved this period yields one Euro plus (one Euro times the rate of interest) next period. Or . . .
I0
I11
1+i
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10
0 0 0 0( ) saved yields (1 )( ) next period.I C i I C
0 0( )I C
Inter-temporal Choice
I1 , C1
I0 , C0
From the Endowment Point, where can Saving take you?
E
Or . . .
I0
I1
0 0(1 )( )i I C
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10
0 0 0 0( ) saved yields (1 )( ) next period.I C i I C
0 0( )I C
Inter-temporal Choice
I1 , C1
I0 , C0
From the Endowment Point, where can Saving take you?
What is the slope of the budget constraint?
E
Or . . .
I0
I1
0 0(1 )( )i I C
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10
0 0 0 0( ) borrowed reduces consumption by (1 )( ) next period.C I i C I
Inter-temporal Choice
I1 , C1
I0 , C0
From the Endowment Point, where can Borrowing take you?
E
Or . . .
I0
I1
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
From the Endowment Point, where can all possible Saving or Borrowing take you?
This is the inter-temporal budget constraint.
E
I0
I1
Slope = (1 )i
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
What is the value of C1?
(Note the value of the slope.)
E
I0
I1
(1 )i
C1
C0
1 1 0 0 +(1 )( ).C I i I C
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
Re-arranging:
E
I0
I1
(1 )i
C1
C0
1 1 0 0
1 10 0
+(1 )( )
+(1 )
C I i I C
I CC I
i
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
This is the horizontal intercept of the budget constraint. What is its interpretation?
E
I0
I1
10 (1 )
II
i
C1
C0
1 10 0
1
10 0
+(1 )
If we now let =0, then:
+(1 )
I CC I
i
C
IC I
i
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10
10 (1 )
II
i
Inter-temporal Choice
I1 , C1
I0 , C0
How would you show the effect on the inter-temporal budget constraint of a fall in the rate of interest?
E
I0
I1
C1
C0
(1 )i
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10
10 (1 )
II
i
Inter-temporal Choice
I1 , C1
I0 , C0
What happens to the Present Value of E after a fall in the rate of interest?
E
I0
I1
C1
C0
(1 )i
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
How would you represent an individual’s preferences over consumption today and tomorrow?
E
I0
I1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
What does the slope of the indifference curve represent?
If the MRTP is high (low), what does this mean?
E
I0
I1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
Optimisation.
E
I0
I1
A
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
Is this person saving or borrowing?
E
I0
I1
A
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
How will they respond to a fall in the rate of interest?
What is your intuition?
Note: borrowing is cheaper . . .
E
I0
I1
A
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
How will they respond to a fall in the rate of interest?
Consider the substitution effect.
E
I0
I1
A
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
Borrowing is cheaper and so the borrower borrows more (Substitution effect).
They are also better off (why?): so there is an Income effect.
Which way does Income effect go?
E
I0
I1
A
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
Borrowing is cheaper and so the borrower borrows more (Substitution effect).
They are also better off (why?): so there is an Income effect.
Which way does Income effect go?
E
I0
I1
A
C0
C1
‘S’ ‘I’
B
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
So fall in the rate of interest leads Borrower to borrow more: unless Consumption today is a . . . . ‘?’ Good.
E
I0
I1
A
C0
C1
‘S’ ‘I’
B
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
How would you show the effect on a Borrower of a rise in the interest rate?Will the Borrower borrow more or less? On what does your answer depend?E
I0
I1
A
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
How would you show the effect on a Saver of a rise in the interest rate?
Will the Saver save more or less? On what does your answer depend?
E
I0
I1
A
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Inter-temporal Choice
I1 , C1
I0 , C0
How would you show the effect on a Saver of a fall in the interest rate?
Will the Saver save more or less? On what does your answer depend?
E
I0
I1
A
C0
C1
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Robin Naylor, Department of Economics, Warwick
Topic 1 Lecture 10Intertemporal Choice
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1 20 2
We saw earlier that .(1 )
Suppose that there are more than the 2 periods:
... .(1 ) (1 ) (1 )
Suppose the stream of Income from an Investment is constant and net of costs:
nn
IPV I
i
II IPV I
i i i
NPV I
2
... .(1 ) (1 ) (1 )
If the income is in Perpetuity, then we have the remarkably simple result that:
.
What is the implication of this for the effect of on Investment?
n
I I I
i i i
INPV
ii
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Robin Naylor, Department of Economics, Warwick
Topic 1: Lecture 10
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Now read B&B 4th Ed., pp. 126-130; 144-149
(but don’t worry about issues (especially the mathematical material) which go beyond what you have seen in lecture notes or seminar exercise sheets)
