econ120511 - Microeconomics December 5th, 2011 Financial...

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Microeconomics December 5 th , 2011 Financial Markets What they are supposed to do… … And why they fail. Big Ideas 1. We have financial markets to allocate risk over time, the risk of investing in an activity with uncertain returns. 2. Orthodox economists assume financial markets will be efficient because large, risk- neutral investors will assume risk and competition will protect others. 3. Financial market competition is limited by asymmetric information, and large investors take on too much risk because of moral hazard. Big question facing all economies, and all individuals Consume now or in the future? Jam today/yesterday or jam tomorrow? We defer consumption now to invest to get more in the future. Instead of eating our seed-corn, we plant it. We defer eating it so we can get more corn in the future. We compare future and present by calculating “present value” PV t = M t+1 /(1 + r) Present value now (t) is the value of next year (t + 1) divided by a discount factor (1 + your interest rate) Ex: Do you put $100 in the bank if they will give you $102 in one year? Put money in the bank only if your interest rate is less than 2%.
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This note was uploaded on 04/04/2012 for the course ECON 103 taught by Professor Voorheis during the Fall '08 term at UMass (Amherst).

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econ120511 - Microeconomics December 5th, 2011 Financial...

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