ECON10A_12

ECON10A_12 - ReviewSupplyofCapital 1/4/2008 1 Discounting...

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1/4/2008 1 Review – Supply of Capital
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1/4/2008 2 Discounting Consumption in future is not as valuable as consumption today Interest rate r is one way to capture this $1 today→$(1+r) next period $1 next period→$1/(1+r) today
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1/4/2008 3 Budget Constraint - Algebraically I 1 income in period 1 I 2 income in period 2 Express total income in present dollars: I 1 + I 2 /(1+r) Budget line: c 1 + c 2 /(1+r)= I 1 + I 2 /(1+r) p 1 x 1 +p 2 x 2 = I 1 + I 2 /(1+r) p 1 =1, p 2 =1/(1+r) “Price” of $1 now is $1 now “Price” of a future dollar of consumption is 1/(1+r) dollars now. Give up 1 units present consumption→ Can consume (1+r) in future Budget line: c 1 + c 2 /(1+r)= I 1 + I 2 /(1+r) C 1 C 2 I 1 I 2 Slope= -(1+r)
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1/4/2008 4 Indifference Curves U(c 1 , c 2 ) MRS=mu 1 /mu 2 Diminishing MRS C 1 C 2 I 1 I 2
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1/4/2008 5 Putting It All Together - graphically Max U(c 1 ,c 2 ) s.t. c 1 +c 2 /(1+r) = I 1 +I 2 /(1+r) Tangency Condition Optimum occurs where: Slope of indif cuirve = Slope of budget line Budget condition Optimum must be on budget line c 1 +c 2 /(1+r) = I 1 +I 2 /(1+r) C 1 C 2 I 1 I 2 r c c mu c c mu + = 1 ) , ( ) , ( 2 1 2 2 1 1 C 1 * C 2 *
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Question 1 If interest rate is 5%, what is c 2 *? A. 79 B. 80 C. 85 D. 100 E. Can’t Tell 1/4/2008 6 c 1 c 2 100 100 120 c 2 *
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Question 1 If interest rate falls, c 2 * will A. Rise B. Fall C. Can’t tell 1/4/2008 7 c 1 c 2 100 100 120 c 2 *
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1/4/2008 8 Supply of Goods and Services
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1/4/2008 9 Overview We learned how households choose quantity of a given commodity they will consume, given prices and income. (Quantity demanded) But goods must be produced (i.e., supplied). We have yet to see how firms choose the quantity of
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This note was uploaded on 12/20/2011 for the course ECON 10a taught by Professor Babcock during the Fall '11 term at UCSB.

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ECON10A_12 - ReviewSupplyofCapital 1/4/2008 1 Discounting...

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