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EC1B3 > Week 9: Consumption and Savings II > Flashcards

Week 9: Consumption and Savings II Flashcards

1
Q

Diagram for Different Interest Rates for Borrowers and Lenders

A
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2
Q

Interest Rates for Borrowers Increases Diagram

A
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3
Q

4 consequences of an increase of borrowing rate?

A
  1. increased cost of borrowing - less likely to borrow
  2. more likely to save as improved returns
  3. higher mortgage repayments
  4. economic growth will slow
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4
Q

Increased Borrowing Rate Diagram with Intertemporal Preferences

A
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5
Q

Why does Ricardian Equivalence not hold when the borrowing rate changes? 3 reasons

A
  • tax changes change the endowment point
  • tax changes with imperfect credit market modify the bundles that can be reached by consumers
  • consumers choose another allocation
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6
Q

Collateral Definition

A

an item of value that a lender can seize from a borrower if he or she fails to repay a loan according to the agreed terms

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7
Q

How does a collateral work with a lender?

A

Lender may not trust the borrower - borrower promises to pay the debt in second period but don’t pay
Lender asks borrower to post a collateral (asset - house, car, gov bond etc.) and if borrower does not pay lender keeps the asset

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8
Q

What are the simplifying assumptions for collaterals and credit markets? (2)

A
  1. interest rates is the same for borrowers and lenders

2. collateral cannot be sold in first period

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9
Q

Consumption equation with house (price per square metre) as collateral

A
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10
Q

Consumption diagram with house (price per square metre) as collateral

A
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11
Q

What do lenders request with a collateral?

A

Repayment from borrower must be lower than or equal to the value of the house

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12
Q

Diagram for how much someone can borrow using a collateral

A
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13
Q

What happens if the price of a collateral decreases? Diagram

A
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14
Q

What happens if the price of a collateral decreases?

A

Reduces the amount and maturity of firm debt

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15
Q

Precautionary Saving

A

Saving just in the case of an uncertain and unpredictable event

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16
Q

3 main findings from evidence from household consumption

A
  1. low income - behave as if borrowing is constrained, engage in precautionary saving, MPC from income boost is high 2. above avg income - consumption smoothing effective, MPC from temp income shocks is low 3. many departures from classical model in data
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17
Q

Marginal Propensity to Consume (MPC)

A

the proportion of an aggregate raise in pay that a consumer spends on the consumption of good and services

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18
Q

Consumption Smoothing

A

creating a balance between spending and saving during the different phases of our lives to achieve a higher overall standard of living

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19
Q

Investment

A

an asset or item acquired with the goal of generating income or appreciation - todays investment influences future opportunities

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20
Q

How do firm’s make investment decisions?

A

Keep investing in capital until MPK = difference between real interest rate and growth rate of the price of capital

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21
Q

Marginal Product of Capital (MPK)

A

the amount of extra output the firm get from an extra unit of capital, holding the amount of labour constant

22
Q

Two ways to invest

A
  1. save money in the bank

2. buy new capital

23
Q

Arbitrage Equation

A
24
Q

Arbitrage Equation Rearranges with P(k,t) = 1

A
25
Q

User Cost of Capital

A

the unit cost for the use of a capital asset for one period – the price of employing or obtaining one unit of capital services

26
Q

Arbitrage Equation/Arbitrage Pricing Theory

A

multi-factor asset pricing model based on the idea that an asset’s returns can be predicted using the linear relationship between the assets’ expected return and several macroeconomic variables that capture systematic risk

27
Q

Growth Rate in Price Equation

A
28
Q

What does it mean if growth rate is positive or negative?

A

Positive - ‘capital gain’

Negative - ‘capital loss’

29
Q

Why does price of capital change? (3 reasons)

A

Depreciation
Technological change in electronics
Scarce resources

30
Q

Arbitrage Equation that Includes Depreciation

A
31
Q

User cost of capital

A

total cost to the firm of using one more unit of capital

32
Q

How much should a firm invest? Diagram

A
33
Q

Add a Tax Component (τ) to Investment Equation

A
34
Q

Rearrange the Investment Equation with Tax Component for MPK (when MPK = user cost of capital)

A
35
Q

Increase in Corporate Income Tax Diagram

A
36
Q

Method to calculate investment rate from desired capital

A
  1. using production function, MPK and standard accumulation formula
  2. rearrange MPK equation to Y/K = 3.uc
  3. Rewrite capital accumulation equation: △K(t+1) = I(t) - dK(t)
  4. divide both sides by K(t)
  5. Sub in 3uc for Y/K
  6. Investment rate
37
Q

Investment Rate Equation

A
38
Q

What 3 terms does the investment rate depend on?

A
  1. desired growth rate of capital
  2. depreciation
  3. user cost of capital
39
Q

Arbitrage Equation and the Price of a Stock

A
40
Q

How to solve arbitrage equation for the price of the stock?

A
  1. divide both sides by price of stock

2. solve for price of stock

41
Q

Arbitrage Equation solved for price of stock

A
42
Q

Price-Earnings (P/E) Ratios

A

ratio for valuing a company that measures its current share price relative to its earnings per share (EPS)

43
Q

P/E Ratio Equation

A
44
Q

Characteristics of Informationally Efficient Markets (3)

A
  • financial prices fully and correctly reflect all available info
  • impossible to make economic profits by trading on basis of info
  • theory states that only unexpected news moves stock prices
45
Q

Mutual Funds Definition

A

a type of financial vehicle made up of a pool of money collected from many investors to invest in securities such as stocks, bonds, and other assets

46
Q

Types of Mutual Funds

A

Actively managed: constant buying and selling, deliver high returns with low risk, higher fees
Index funds: managed by a single computer program, designed to imitate major stock index

47
Q

What is Tobin’s model?

A

the only asset a firm has is its capital - stock value of firm is the value of the capital stock

48
Q

Tobin’ Equation

A
49
Q

What does it mean if q > 1 and q < 1 in Tobin’s Equation

A

q < 1 - value of firm is greater than the value of capital - firms should invest in more capital
q > 1 - value of firm is less than value of capital - firms should disinvest

50
Q

2 basic predictions in Tobin’s equation

A
  1. value of q should be close to 1

2. value of q should be a useful predictor of firm investment

EC1B3 (10 decks)

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