Microeconomics Corso E

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MicroeconomicsCorso E

• John Hey

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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.

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Intertemporal Choice

• Chapter 20 the budget constraint.
• Chapter 21 intertemporal preferences the
  Discounted Utility Model.
• Chapter 22 intertemporal exchange.

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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

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When you borrow
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When you borrow
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When you borrow
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When you borrow
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When you borrow
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When you borrow
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When you save
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When you save
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When you save
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When you save
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When you save
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When you save
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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 (1r)

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The Budget Line 1.

• m1 gt c1 savings m1 - c1
• Becomes (m1 - c1)(1r) in period 2.
• Hence c2 m2 (m1 - c1)(1r).
• Or
• c1(1r) c2 m2 m1(1r).
• In the space (c1 ,c2) a line with slope -(1r).

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The Budget Line 2.

• m1 lt c1 borrowings c1 - m1
• Have to repay (c1 - m1)(1r) in period 2.
• Hence c2 m2 - (c1 - m1)(1r).
• Or
• c1(1r) c2 m2 m1(1r).
• In the space (c1 ,c2) a line with slope -(1r).

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The Budget Line 3.

• maximum consumption in period 2
• m1(1r) m2
• - this is called the future value of the stream
  of income.
• maximum consumption in period 1
• m1 m2/(1r)
• - - 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.

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The Budget Line 4.

• The intercept on the horizontal axis
• m1 m2/(1r)
• the present value of the stream of income..
• The intercept on the vertical axis
• m1(1r) m2
• the future value of the stream of income...
• The slope -(1r)

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Generalisation

• If the individual receives a stream of income
• m1, m2, m3 mT
• The present value is
• The future value is

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An imperfect market (10 and 51)
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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.

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