Intertemporal choice

Question 1

What is intertemporal choice?

Answer 1

Studies how much an individual earns, consumes, saves and borrows over their lifetime.

Question 2

What are the features of Robinson Crusoe economy?

Answer 2

One agent
no saving/investment
fixed quantity of one resource (24 hours)

Question 3

What shape is the indifference curve in RC economy?

Answer 3

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.

Question 4

What shape is the production function?

Answer 4

Concave due to law of diminishing marginal returns, slope = MPL.

Question 5

What is the optimal choice of production and consumption in RC economy?

Answer 5

Where the IC is tangent to the production function so MRS=MPL

Question 6

What is assumed about Robinson Crusoes firm/customers?

Answer 6

they are profit and utility maximisers.

Question 7

What is the Iso-profit line? What is the equation, slope and intercept?

Answer 7

how profit changes given labour hours and number of coconuts gathered.
C = profit + wL
intercept = profit
slope = W

Question 8

Where does RC firm profit maximise?

Answer 8

Where the PPF = Iso profit line (tangent). MPL=W.

Question 9

Why might a firm not be able to acheive the highest Iso-profit line?

Answer 9

due a lack of technology which restricts the PPF rising.

Question 10

Where does the RC consumer optimise their consumption and maximise utility?

Answer 10

where the IC curve and budget constraint are tangent. MRS = W.

Question 11

What is the budget constraint equation in RC economy?

Answer 11

C = Profit (income as firm owner) + WL (income as workers)

Question 12

What efficiency is in RC’s market?

Answer 12

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.

Question 13

What are the following equations;
- utility function
- production function
- time constraint

Answer 13

• U = Y (output) x l (leisure)
• Y = (square root of hours of work)
• l+h = 24

Question 14

What does the life cycle model show?

Answer 14

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)

Question 15

WHat is the intertemporal budget constraint ?

Answer 15

Shows possible combos of current and future consumption for 1 person and the trade off between present and future consumption.

Question 16

What are the assumptions of the life cycle model?

Answer 16

-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)

Question 17

What is the budget constraint for consuming today?

Answer 17

C + S = y- t

Question 18

What is the budget constraint for consuming tomorrow?

Answer 18

C’ = y’-t’ + (1+r)S

Question 19

How will tomorrows budget constraint change if savings are negative?

Answer 19

c’=y’-t’ - (1+r)S as they owe a party money

Question 20

What is the formula for intertemporal budget constraint?

Answer 20

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

Question 21

What are the slope and intercept of the intertemporal budget constraint?

Answer 21

intercept = (1+r)we and slope = -(1+r) showing the trade off, buying more today = able to buy less tomorrow.

Question 22

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?

Answer 22

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.

Question 23

What does the endowment point?

Answer 23

Represents what consumers are endowed with in the future and present.