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Lecture%2012%20-%20Intertemporal%20Supply%20and%20Markets

Lecture%2012%20-%20Intertemporal%20Supply%20and%20Markets -...

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1 FIN 501 Financial Economics Session 12: Intertemporal Consumption II,  Intertemporal Supply & Markets. Professor Nolan Miller
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2 Announcements Problem Set #4 is due Thursday, October 7. Midterm exams … I’m happy to talk to you about the exam.  But: The suggested solution is online.  Please look at it first before you come see  me.  It is a useful exercise for you to try to figure out the questions rather  than have me explain them to you.
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3 Road Map Last time: basic theory of consumption over time. Today: Catch up (MSF1/MSF2) on Consumption with income, Fisher’s  theorem. Separable Utility Hyperbolic Model Intertemporal Supply Stocks and Flows Demand for Capital There’s far more in today’s slides than we’re likely to cover.
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4 Consumption with income Key observation:  No matter  what the interest rate, the  consumer can always consume  his income each period. So, the intertemporal budget line  always goes through (m 0 ,m 1 ). Increasing r makes the budget  line (slope – (1+r)) steeper. Budget line, high r Budget line, low r C 0 C 1 m 0 m 1
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5 Consumption with income Two cases to consider: Borrowing in period 0: C 0  > m 0 C 1  < m 1 Interest rate increase makes  consumer poorer. Saving in period 0: C 0  < m 0 C 1  > m 1 Interest rate increase makes  consumer richer. C 0 C 1 m 0 m 1 Saves in period 0 Borrows in  period 0
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6 Effect of an increase in r: borrower Consider a borrower at time 0. C 0 *  > m 0 . If r increases, cost of borrowing  increases. Subst effect reduces consumption. Because borrower becomes poorer,  inc. effect is also negative. C 0  must go down. C 0 C 1 m 0 m 1 C 0 * C 1 *
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7 Effect of an increase in r: saver Consider a saver at time 0: C 0 * <m 0 . If r increases, consumer becomes  richer. Substitution effect leads to lower C 0 . But, since C 0  is normal, income  effect increases C 0 . Net effect is ambiguous. Here, r increases, and C 0  increases. C 0 C 1 m 0 m 1 C 0 * C 1 *
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8 Timing of income Suppose this consumer faces the choice between two income streams. 1. Go directly to the labor market, earn a moderate wage. 1. Go to school for one year, pay tuition and earn no wage, but then earn a high  wage thereafter. Question: Which should the consumer choose? Pre-Question: what factors should be important in the decision? Interest rate. Consumer’s preferences for early/late consumption.
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9 Timing of income In principle, the answer should depend on whether the consumer is  impatient, and wants to consume right away, or patient and is willing to  wait to get the higher income.
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