Intertemporal choice Flashcards
What is intertemporal choice?
Studies how much an individual earns, consumes, saves and borrows over their lifetime.
What are the features of Robinson Crusoe economy?
One agent
no saving/investment
fixed quantity of one resource (24 hours)
What shape is the indifference curve in RC economy?
Upward sloping as labour hours is on the horizontal axis and as labour hours are increased there are less hours for leisure so utility decreases.
What shape is the production function?
Concave due to law of diminishing marginal returns, slope = MPL.
What is the optimal choice of production and consumption in RC economy?
Where the IC is tangent to the production function so MRS=MPL
What is assumed about Robinson Crusoes firm/customers?
they are profit and utility maximisers.
What is the Iso-profit line? What is the equation, slope and intercept?
how profit changes given labour hours and number of coconuts gathered.
C = profit + wL
intercept = profit
slope = W
Where does RC firm profit maximise?
Where the PPF = Iso profit line (tangent). MPL=W.
Why might a firm not be able to acheive the highest Iso-profit line?
due a lack of technology which restricts the PPF rising.
Where does the RC consumer optimise their consumption and maximise utility?
where the IC curve and budget constraint are tangent. MRS = W.
What is the budget constraint equation in RC economy?
C = Profit (income as firm owner) + WL (income as workers)
What efficiency is in RC’s market?
Pareto efficient as QD of labour = QS of labour and QD of coconuts = QS of coconuts so the market clears where the budget constraint is tangent to the production function and the IC curve.
What are the following equations;
- utility function
- production function
- time constraint
- U = Y (output) x l (leisure)
- Y = (square root of hours of work)
- l+h = 24
What does the life cycle model show?
consumption and saving decisions in a year are an outcome of a decision process that takes into account liftetime economic circumstances
It analyses the budget constraint over time (intertemporal budget constraint)
WHat is the intertemporal budget constraint ?
Shows possible combos of current and future consumption for 1 person and the trade off between present and future consumption.
What are the assumptions of the life cycle model?
-Economy consists of consumers
-two time periods (today and tomorrow)
-consumers earn (y)/(y’), consume (c)/(c’) and pay (t)/(t’) today/tomorrow
-borrow/lend at real interest rate (r)
What is the budget constraint for consuming today?
C + S = y- t
What is the budget constraint for consuming tomorrow?
C’ = y’-t’ + (1+r)S
How will tomorrows budget constraint change if savings are negative?
c’=y’-t’ - (1+r)S as they owe a party money
What is the formula for intertemporal budget constraint?
C’/(1+r) + C = y’-t’ / (1+r) + (y-t) where the right hand side of the equation is equal to all the money they will have over their lifetime / wealth. Rearranged to c’ = (1+r)we - (1+r)C
What are the slope and intercept of the intertemporal budget constraint?
intercept = (1+r)we and slope = -(1+r) showing the trade off, buying more today = able to buy less tomorrow.
Why does the IC curve need to lie tangent to the budget constraint above the endowment point if they are a lender?
Why does the IC curve need to lie below the endowment point if they are a borrower?
Because present consumption is less than future so they may place thier savings in a bank.
Consumption is higher than what they earn today so have to borrow.
What does the endowment point?
Represents what consumers are endowed with in the future and present.
