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I. Consumption Time Preferences

I. Consumption Time Preferences Consumption vs. spending decision in the two-period world of Fisher Insert 3.1 Plotting preferences Ô indifference curves Diminishing marginal utility Ô convex indifference curves Insert 3.2 II. The Investment Opportunity Set

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I. Consumption Time Preferences

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  1. I. Consumption Time Preferences • Consumption vs. spending decision in the two-period world of Fisher • Insert 3.1 • Plotting preferences Ô indifference curves • Diminishing marginal utility Ô convex indifference curves • Insert 3.2 • II. The Investment Opportunity Set • Plotting investment opportunities Ô investment opportunity set • Insert 3.3 & 3.4 • Selecting best to worst investments Ô diminishing marginal returns to investment Ô concave curve • Insert 3.5 & 3.6 Fundamentals of Interest Rate Determination

  2. III. Capital Market Opportunities and Budget Lines • Capital market opportunity lines Ô Budget lines • Insert 3.7 • Horizontal intercept = Present value • Insert 3.8 • Vertical intercept = Future value • With capital markets everyone is at least as well off as before, and some are better off. • Insert 3.9 • Capital flows from savers to investors to maximize total wealth. Both sides gain. How is this possible? Question: Suppose we were to look at emerging markets in this way. What are the implications? Question: What happens in this framework when a disaster strikes a region or a country?

  3. A. Interest rate spreads The effect of different borrowing and savings rates • Insert 3.10 • Question: What is the implication of rate spreads on social • welfare? What is the gain from their elimination? • B. Market equilibrium for interest rates • Deriving supply and demand curves in a two-person world • Insert 3.11 • Aggregating individual supply and demand schedules • Insert 3.12 Ô economy-wide supply and demand schedules Ô economy-wide supply and demand intersection Ô equilibrium interest rate • IV. The Aggregate Loanable Funds Market Comprised of individuals, firms or governments, each with their own demand and supply curves for loanable funds • Insert 3.13

  4. V. Summary • Interest rates affect individual decisions on consumption / saving • Capital markets improve utility • Loanable funds approach to interest rate determination • Aggregating across individuals yields market demand and supply for credit Ô equilibrium interest rate

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