Financial Theory: Lecture 13 Transcript
October 15, 2009
Professor John Geanakoplos:
All right, so I'm going to finish talking about overlapping generations today.
I'm going to defer my plan to save Social Security till a couple of lectures from now, and I'm going to start to
introduce uncertainty in this class.
The exam will only cover the stuff up to basically the last problem set. There are a few things about
overlapping generations I might say today, which will clarify what you already know, but you don't have to
know anything beyond the problem you turned in on Thursday--you're turning in today. So you I think are
better informed now than you were yesterday. I think it's a big help to be doing the problems, so for those of
you watching on screen at home, do the problems.
So remember we had a situation where there were generations, each of whom was rich when young and poor
when old, that looked like that. And it went on forever. That was the only difference from what we've had
before. People's lives were shorter than the lifetime of the economy, and to go to the extreme, the economy
goes on forever, even though people only live two periods.
And then there was land, 1, 1, 1, 1. There's land, and then there's generation--because I forgot the generation--
here's generation 0, generation 1, generation 2, generation 3.
.. and time. This is time. And here's time 1, time
2, time 3, time 4, time 5, etc. Now this model, I've been told, is the hardest thing you do the entire class.
Things are going to get much more complicated, but since they build up slowly, I think this model's the
hardest thing you have to do the entire class.
I realize it's a little bit confusing, but in the end, I don't think it's that complicated. And it reveals all the
subtlety of Fisher's thinking, not that Fisher understood about overlapping generations, but his ideas, you can
So what are his ideas? You've got a complicated model in which you've got people trading apples when
they're young, against land. So the objects in the economy are land, which you're supposed to think of as the
stock market, okay, so we've got land and we've got apples.
Now what's interesting is, the land is going to constantly change hands. So the young here are going to buy
the land, but when they get old, they're going to sell the land. So the land is constantly changing hands. It's
not that one person buys it at the beginning and holds it forever.
So Fisher's formula, remember, was that the price of any asset was going to be equal to the discounted
dividends. And the logic seemed to be at the time that the price, you know, if the person was going to buy the
asset, that they could take the money now or they could wait and get all the dividends in the future, and they
would compare what they would get out of the dividends in the future to what they have to give up today.