(5.2) Intertemporal consumption

Question 1

When we plot PV against FV on axis, what will the gradient of the slope represent?

Answer 1

interest rate

Question 2

3

What are the primitives for the intertemporal consumption model?

Answer 2

• DM: individual
• Set of alternatives: How much to consume today (c₀) vs tomorrow (c₁)
• Preferences: Utility function u(c₀, c₁)

Question 3

2

What does intertemporal consumption allow for?

Answer 3

• to decide consumption at each period
• how much to save/borrow, given particular stream of income after investment decisions made

Question 4

5

What are the assumptions in the intertemporal consumption model?

Answer 4

• Two time periods: 0 (present) and 1 (future)
• Income streams: y₀ and y₁ (endowments from investments)
• PCM: Can save/borrow at interest rate r
• No money: Everything in real terms
• Utility maximisation: Subject to intertemporal budget constraint

Question 5

What type of variable is ‘r’ in the intertemporal consumption model?

Answer 5

fixed exogenous

Question 6

3

Give the expression for period 0 (borrowing/saving) of intertemporal consumption

Answer 6

• s₀ = y₀ - c₀
• saving if >0
• borrowing if <0

Question 7

3

Give the expression for period 1 (dissaving/repaying debt) of intertemporal consumption

dissaving - spending more than one has earned in specific time period

Answer 7

• c₁ = y₁ + (1 + r)s₀
• dissaving if >0
• repaying debt if <0

Question 8

1

What is the expression of the intertemporal budget constraint?

Answer 8

c₁ = [y₁ + (1 + r)y₀] - (1 + r)c₀

Question 9

What is the slope of the intertemporal budget line?

Answer 9

- (1+r)

Question 10

How do we denote the endowment pt of intertemporal budget constraint?

Answer 10

(y₀, y₁)

Question 11

What is the FV term of intertemporal budget?

Answer 11

c₁ + c₀(1 + r) = y₁ + y₀(1 + r)

Question 12

What is the maximum future consumption pt (for intertemporal consumption)?

Answer 12

y₁ + (1 + r)y₀

Question 13

What is the PV term of intertemporal budget?

Answer 13

c₀ + c₁/(1 + r) = y₀ + y₁/(1 + r)

Question 14

What is the maximum present consumption pt (for intertemporal consumption)?

Answer 14

y₀ + y₁/(1 + r)

Question 15

2

What does the left of the endowment pt on intertemporal budget line represent? What about the right?

Answer 15

• left - saving
• right - borrowing

Question 16

photo

Draw a graph for intemporal consumption

Answer 16

Question 17

3 + photo

What happens to the intertemporal budget line when the interest rate increases?

Answer 17

• Budget line pivots around the endowment point
• New budget line becomes steeper (slope becomes more negative)
• affects the relative price of present vs. future consumption (future becomes relatively cheaper)

Question 18

1

Why does the budget line pivot around the endowment pt when interest rate changes?

Answer 18

• endowment pt represents what consumer can always achieve without using credit markets

Question 19

1

What do we have in intertemporal consumption instead of income?

Answer 19

‘per period endowment’

Question 20

2

Compare govt bonds with small business bonds

Answer 20

• higher default risk for small firm
• so pay higher risk premium

Question 21

2

Where does the endowment point always lie?

Answer 21

• on the budget line
• if consumer decides to not save or borrow, endowment pt is possible and lies on budget line

Question 22

What is another way of saying the opportunity cost of current consumption?

Answer 22

value of saving