borrowers and lenders, where we have the following assumptions: . . . Consumer lives for 2 periods; endowment in period 1 and 2 are y and y' respectively, and pays taxes t and t' in period 1 and 2 respectively. Consume c today and c' tomorrow Assume that lenders can lend at a lower interest rate than the one faced by borrowers; lend at r, borrow at ₂:₂ >r, r₂-r₁: spread arises for compensating the bank for costs of making loans; information asymmetries
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- The consumer views present and future consumption as perfect complements and would like to consume equal amounts in both periods, i.e., . Suppose, however, that there is a credit market imperfection that prevents this consumer from borrowing at all, i.e., . a. Show the consumer's lifetime budget constraint and indifference curves on a diagram. Note that because the consumer prefers to purchase present and future consumption in equal amounts, the indifference curves will be kinked at. Note also that because the consumer cannot borrow, the budget constraint will be kinked at the consumer's initial endowment. Recall that the budget constraint is given by: Recall also that the consumer's endowment for each period can be expressed as: b. Calculate the consumer's optimal current-period and future-period consumption and optimal saving and show this in your diagram. Does the existence of the credit market imperfection affect the consumer's choices? Recall that savings is given by: c. Suppose…D) Discussing the Equilibrium in the Endowment Economy: In the endowment economy, aggregate consumption must equal aggregate endowment ineach period. Using this condition and the optimal consumption functions derived,discuss how the equilibrium real interest rate rtis determined in this economy. Explainthe role of the real interest rate in ensuring equilibrium in the lending market and why itis necessary for achieving this equilibrium (e) Analyzing the Effect of Changes in Relative Risk Aversion:Given the consumption functions, discuss how changes in the coefficient of relative riskaversion (σ) affect the household’s consumption choices and the sensitivity of these choicesto changes in the real interest rate. Provide an intuitive explanation for your findings.2. Consider the two-period endowment model discussed in the lectures where the economy is populated by m consumers and a government. The agents derive utility from consumption in the current and future period. The utility is well behaved. Suppose that the government, instead of borrowing in the current period, runs a government loan program. That is, loans are made to consumers at the market real interest rate r, with the aggregate quantity of loans made in the current period denoted by L. Government loans are financed by lump-sum taxes on consumers in the current period (denoted by T), while government spending is zero in both periods (i.e., G = G' = 0). In the future period, when the government loans are repaid by consumers, the government rebates this amount as lump- sum transfers (negative lump-sum taxes) to consumers. Finally, each consumer shares an equal amount of the total tax burden (or of the total transfer benefit) in the current and future period. (a) Write down the…
- Match the contribution with the appropriate scholar. Who believed that framing the general equilibrium of the entire microeconomy is better treated one market at a time? v Choose... Modigliani Who is considered the father of Modern Portfolio Theory? Marshall Fisher Who demonstrated why people are either savers or dissavers? Keynes Who provided a general existence proof of a competitive equilibrium? Markowitz Ricardo Who developed the distinction between comparative and absolute advantage? Arrow Hotelling Who first developed a working model of options pricing? Bachelier Smith Who argued that competition in physical space can result in minimum differentiation? Choose... Who determined that, unlike the neoclassical microeconomic theory of equilibrium, we may be in a state of persistent Choose... disequilibrium in the macroeconomy? Who considered the regard by others as an important driver of human behavior? Choose... Who developed a complete Life Cycle Model of spending and saving…7 Consider a model in which an individual lives only two periods. This person has diminishing marginal utility of consumption and receives an income of $20,000 in period 1 and an income of $5,000 in period 2. The private interest rate is 10 percent per period, and this person can borrow or lend money at this rate. Also assume that this person intends to consume all of his income over his lifetime. a. Give a hypothetical numerical example of what a person’s optimal consumption would be over these two periods. In answering this question, what assumptions did you make?In the Loanable Funds Market Model, ceteris paribus, it typically follows that when the federal government runs a budget deficit, there will be préssure on interest rates and pressure on private investment. This is referred to as Select one: O a. upward; upward; crowding out Ob. upward; downward; crowding out O c. downward; downward; financial intermediation Od. downward; upward; financial intermediation.
- Consider the two-period endowment model discussed in class where theeconomy is populated by m consumers and a government. The agents derive utilityfrom consumption in current and future period. The utility is well behaved. Supposethat the government, instead of borrowing in the current period, runs a governmentloan program. That is, loans are made to consumers at the market real interest rater, with the aggregate quantity of loans made in the current period denoted by L.Government loans are financed by lump-sum taxes on consumers in the current period(denoted by T), and we assume that government spending is zero in the current andfuture periods (i.e., G = G0 = 0). In the future period, when the government loansare repaid by consumers, the government rebates this amount as lump-sum transfers(negative taxes) to consumers. Hence, if we call T r0the lump sum transfers in thefuture period, then T r0 = −T0 > 0.(a) Write down the government’s current period budget constraint andits future…In this hypothetical economy. there are two consumers living over two periods of life. Ann's incomes are $50.000 in both periods. Meanwhile, Bob earns nothing in the first period but S105,000 in the second period. Both of them can borrow or lend at the interest rate r. For simplicity, assume that there are no taxes A) Ann and Bob consume $50,000 in the first period and $50,000 in the second period. Write down the lifetime budget constraint for each consumer then calculate the interest rate r. Describe the economic behaviour of each consumer. b) Suppose the interest rate increases. What will happen to Ann's consumption in the first period? Is Ann better off or worse off than before the interest rate rises? Explain your answer using an appropriate diagram2. An individual has an intertemporal utility function that is rational, monotonic, and strictly convex. She can borrow/lend at the interest rate, r, but does not have access to human capital. She is currently consuming a bundle such that MRSx₁x2 >1+r. How many of the following statements COULD BE true? [HINT: try drawing a picture] 0 X1x2 The bundle is optimal (i.e. maximizes her utility). If the individual is consuming both goods, she could do better by consuming less today and consuming more tomorrow. She is at a corner solution in which she only consumes tomorrow. a. 1 b. 2 c. 3 V. d. None of the above statements could be true.
- 3. Consider a society of identical individuals who live for two periods. They have the following utility: In co + 3 5 In ci Each individual earns $600 when young, in period 0, and no income in period 1, when old. They can borrow and lend at interest rate r, and the price of consumption is 1. (a) Write down this individual's lifetime budget constraint (b) Solve for this individual's consumption in period, and savings, as a function of r. (c) Suppose now that there is a Social Security program. The gov- ernment collects $ 60 from this individual in period 0, and gives it back with interest r in period 1. i. What kind of social security system is this? ii. What is the new amount of savings? iii. What is the impact of this program on the individual's wel- fare? (d) Suppose some individuals have utility 1 In co +In c₁ 9 The social security system still forces them to save $60. i. If they are still free to borrow and lend at r, what will their optimal choice of consumption and savings be,…Discuss the concept of duality in economics, where concepts like risk and return represent dual aspects of investment decisions. Provide examples from financial markets.Question Two a. Explain the difference between a binding and non-binding borrowing constraints and thetwo consumption functions that result.b. From the Intertemporal Choice Model, many theories (non-Keynesian theories ofConsumption) came into being. Using graphical and mathematical expressions, compareand contrast the following theories on consumption behaviours:i. Franco Modigliani: Life-Cycle Hypothesisii. Milton Friedman: Permanent-Income Hypothesisiii. Robert Hall: Random Walk Hypothesis