Topic 1 Lecture 10

1. Topic 1 Lecture 10 Applications of Consumer Choice Theory 2. Inter-temporal Choice Think of an ‘Endowment Point’ and add it to the diagram. I1 ,C1 I0 , C0 Robin Naylor, Department of Economics, Warwick

2. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Saving take you? (And then Borrowing?) I1 ,C1 E I1 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

3. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Saving take you? I1 ,C1 E I1 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

4. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Saving take you? I1 ,C1 1+i E I1 1 I0 I0 , C0 One Euro saved this period yields one Euro plus (one Euro times the rate of interest) next period. Or . . . Robin Naylor, Department of Economics, Warwick

5. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Saving take you? I1 ,C1 C1 I1 E C0 I0 I0 , C0 Or . . . Robin Naylor, Department of Economics, Warwick

6. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Saving take you? What is the slope of the budget constraint? I1 ,C1 C1 I1 E C0 I0 I0 , C0 Or . . . Robin Naylor, Department of Economics, Warwick

7. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Borrowing take you? I1 ,C1 I1 E C1 I0 C0 I0 , C0 Or . . . Robin Naylor, Department of Economics, Warwick

8. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can all possible Saving or Borrowing take you? This is the inter-temporal budget constraint. I1 ,C1 E I1 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

9. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 What is the value of C1? (Note the value of the slope.) C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

10. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 Re-arranging: C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

11. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 C1 E I1 This is the horizontal intercept of the budget constraint. What is its interpretation? C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

12. Topic 1 Lecture 10 Inter-temporal Choice How would you show the effect on the inter-temporal budget constraint of a fall in the rate of interest? I1 ,C1 C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

13. Topic 1 Lecture 10 Inter-temporal Choice What happens to the Present Value of E after a fall in the rate of interest? I1 ,C1 C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

14. Topic 1 Lecture 10 Inter-temporal Choice How would you represent an individual’s preferences over consumption today and tomorrow? I1 ,C1 E I1 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

15. Topic 1 Lecture 10 Inter-temporal Choice What does the slope of the indifference curve represent? If the MRTP is high (low), what does this mean? I1 ,C1 E I1 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

16. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 Optimisation. I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

17. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 Is this person saving or borrowing? I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

18. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 How will they respond to a fall in the rate of interest? What is your intuition? Note: borrowing is cheaper . . . I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

19. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 How will they respond to a fall in the rate of interest? Consider the substitution effect. I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

20. Topic 1 Lecture 10 Inter-temporal Choice Borrowing is cheaper and so the borrower borrows more (Substitution effect). They are also better off (why?): so there is an Income effect. Which way does Income effect go? I1 ,C1 I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

21. Topic 1 Lecture 10 Inter-temporal Choice Borrowing is cheaper and so the borrower borrows more (Substitution effect). They are also better off (why?): so there is an Income effect. Which way does Income effect go? I1 ,C1 I1 E C1 A B I0 C0 ‘S’ ‘I’ I0 , C0 Robin Naylor, Department of Economics, Warwick

22. Topic 1 Lecture 10 Inter-temporal Choice So fall in the rate of interest leads Borrower to borrow more: unless Consumption today is a . . . . ‘?’ Good. I1 ,C1 I1 E C1 A B I0 C0 ‘S’ ‘I’ I0 , C0 Robin Naylor, Department of Economics, Warwick

23. Topic 1 Lecture 10 Inter-temporal Choice How would you show the effect on a Borrower of a rise in the interest rate? Will the Borrower borrow more or less? On what does your answer depend? I1 ,C1 I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

24. Topic 1 Lecture 10 Inter-temporal Choice How would you show the effect on a Saver of a rise in the interest rate? Will the Saver save more or less? On what does your answer depend? I1 ,C1 A C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

25. Topic 1 Lecture 10 Inter-temporal Choice How would you show the effect on a Saver of a fall in the interest rate? Will the Saver save more or less? On what does your answer depend? I1 ,C1 A C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

26. Topic 1 Lecture 10 Intertemporal Choice Robin Naylor, Department of Economics, Warwick

27. Topic 1: Lecture 10 Now read B&B 4th Ed., pp. 126-130; 144-149 (but don’t worry about issues (especially the mathematical material) which go beyond what you have seen in lecture notes or seminar exercise sheets) Robin Naylor, Department of Economics, Warwick