Lecture%2013%20-%20Choice%20Under%20Uncertainty%20I

Lecture%2013%20-%20Choice%20Under%20Uncertainty%20I - FIN...

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1 FIN 580 FE1/2 Financial Economics Lecture 13: Choice Under Uncertainty Professor Nolan Miller
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2 Announcements Problem Set #4 due Thursday. Problem Set #5 due October 19. Available on Compass later this week. Office Hours This Week: NM: Wed. 2 – 4pm. If you haven’t gotten your midterm yet, it is in my office.  You can pick it  up during my office hours.
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3 Game Plan for Today Finish up some intertemporal ideas on the supply side. Choice Under Uncertainty: Quick review of basic ideas from probability/statistics. Time Permitting: Attitudes toward risk (risk neutral, risk averse, risk loving)
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4 Intertemporal Issues in Supply Up to this point, we have only discussed the consumer side of intertemporal  decision making. You spend a lot of time on some aspects of this problem in Corporate Finance  (e.g., NPV). I’m going to try to avoid those issues, highlight some others that have more of a  “market” flavor to them.
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5 The supply of future goods Today, the world has an endowment of current goods. These goods can either be consumed today or turned into goods for future  consumption. Transforming current goods into future goods is costly (e.g., storage, planting  seeds to produce future plants, etc.). This cost function can be used to generate a supply curve for future goods. Supply of future goods at a price P is the Q where P = MC. Basic intuition: if the relative price of future goods increases (r goes down) then  firms will want to produce more future goods and fewer current ones.
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6 Equilibrium Price of Future Goods P 1 C 1 Supply Demand C 1 * P 1 * Recall: P 1  = 1/(1+r) The supply and demand  for future goods determines interest rates
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7 So why is r>0? The equilibrium price P 1 = 1/(1+r * ), so it determines equilibrium real interest  rates. Both supply and demand factors can increase real interest rates. Demand: How impatient people are. Income Current consumption may be substitute or complement. Supply Capital accumulation is “productive” (growing trees, aging wine). Production costs for future goods may be lower (technological  progress, build a new plant, etc.).
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8 Durable Goods: Stocks and Flows Think about demand for a long-lasting good. Housing Machines We call such goods “durables” These goods are best thought of in terms of a stock and flow model. There is a 
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Lecture%2013%20-%20Choice%20Under%20Uncertainty%20I - FIN...

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