Ch3_Slides (1).pdf - CHAPTER S A V I N G S AND 3 INVESTMENT...

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C H A P T E R3S A V I N G S,I N V E S T M E N TA N DG O V E R N M E N TD E F I C I T S1 / 148
Objectives of this chapterIDynamic decisions of consumers who maximize their intertemporal utilityfunctionIOptimal allocation of the current income between consumption andsavingsIConsequences of credit market imperfectionsIAsymmetric information: The interest rate applied to borrowers isgreater than that applied to lendersILimited commitment: Borrowers have to post collateral in order toobtain a loanIConstruction of a complete intertemporal macroeconomic modelIDynamic decisions of consumersIInvestment decisions of firmsIAnalysis of the effects of shocks and economic policies2 / 148
P A R T1AT W O - P E R I O DM O D E LT H EC O N S U M P T I O N - S A V I N GD E C I S I O NA N DT H EC R E D I TM A R K E T3 / 148
The consumer’s lifetime budget constraintIm(large number of) consumersIConsumers live two periods (current period and future period)IConsumers make decisions concerning consumption and savingsITradeoff between current and future consumptionIA reduction in current consumption permits to buy financial assetsand to consume more in the future periodIThe work-leisure decision in not taken into account4 / 148
IThe current period budget constraint for a consumer with no initial assetsis:c+s=y-tcCurrent consumption (in real terms)sCurrent saving (in real terms)yCurrent income (in real terms)tCurrent lump-sum tax (in real terms)IThus:s>0c<y-tThe consumer is a lender and buys bondss<0c>y-tThe consumer is a borrower and sells bondsIBonds are issued by borrowers and bought by lendersIIdentical and riskless assets (no default risk)IAbsence of financial intermediaries (banks)5 / 148
IThe future period budget constraint for a consumer is:c0y0-t0+ (1 +r)·sc0Future consumption (in real terms)y0Future income (in real terms)t0Future lump-sum tax (in real terms)sCurrent saving (in real terms)rReal interest rateIConsidering that more is always preferred to less, in order to maximizeutility, the future period budget constraint becomes:c0=y0-t0+ (1 +r)·s6 / 148
IBonds give areal interest rater(assumed to be the same for lenders andborrowers)IQuantity of additional goods that a lender can obtain in the futureperiod for each unit of bonds that he buys in the current periodIQuantity of additional goods that a borrower has to pay in the futureperiod for each unit of bonds that he issues in the current periodI1 unit of current consumption can be exchanged with 1 +runits of futureconsumptionI1 +r:IOpportunity cost of current consumption (quantity of futureconsumption that the consumer gives up if he increases the currentconsumption by 1 unit)IRelative price of current consumption in terms of future consumptionIThus:IIfrincreasesCurrent consumption becomes more expensiverelative to future consumption
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ILifetime budget constraintfor a consumerc+c01 +ry+y01 +r-t-t01 +rIc+c01+rPresent value of lifetime consumptionIy+y01+r

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