# 321_6 - amount of money you will have if you save it = \$...

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ECON 321 Spring 2011: Lecture 6 Chapter 10: Intertemporal Choice Note: skipped 8 and 9

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Definitions (Chpt 10) Time period : a unit of time, could be a day, month, year, etc. Interest rate : r ~ a number that is usually less than 1 and bigger than zero. If I lend someone \$ m at interest rate r, I receive: \$(1+r)m, after 1 period \$(1+r)(1+r)m = \$(1+r) 2 m, after 2 periods \$(1+r)…(1+r)m = \$(1+r) t m, after t periods
More Definitions (Chpt 10) Inflation : the increase in the price of consumption = an increase in the price level = devaluation of money Present value of a future monetary payoff = amount of money that if you lend it today would earn interest to equal the future payoff For example, if I promise you \$M tomorrow, it is worth \$M/(1+r) today More generally, a payoff of \$M in t periods is worth \$M/(1+r)t , today Future value of a current monetary payoff = the

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Unformatted text preview: amount of money you will have if you save it = \$ M(1+r) Group Problem • Your income today is \$2,000. Next year your income will be \$1,100. Your utility from consumption now and next year is: • What is your optimal choice if the interest rate is 10%? • What is your optimal choice if the interest rate is 20% 2 1 2 1 ) , ( c c c c u = Practice Problem • You have \$60 today and will earn \$60 next period. You can borrow at a 200% rate of interest and you can lend/save at 0%. – Graph your intertemporal budget set – You have a chance to invest in a project to get \$90 today and \$45 next period. Should you? – What if the project paid \$45 today and \$90 next period? Problem • Your utility is: • Interest is 21%, m 1 = 2000, m 2 =1100 • Calculate optimal choice. } , min{ ) , ( 2 1 2 1 c c c c u =...
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321_6 - amount of money you will have if you save it = \$...

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