Buying and Selling: Applications

Review Model of choice We know preferences and we find The two differences – net demands Buying, selling?

More generally x2 w2 w1 x1

Three Applications 1. Labor Supply (Labor-Leisure Choice) 2. Intertemporal Choice (Consumption-Savings Choice) 3. Uncertainty (Insurance) (Consumption across states of the world)

Intertemporal Choice Two periods: Today and Tomorrow Goods: consumtion today and tomorrow Endowment: income today and income tomorrow Possibility of borrowing and lending

Intertemporal Choice

Intertemporal Budget Constraint

Present Value (PV) and Future Value (FV) The interest rate is FV: Future equivalent of today’s $1 PV: Today’s equivalent of tomorrows $1 What is PV and FV of cashflow

Budget constraint (2 versions) FV of spending = FV of income PV of spending = PV of income Prices and income

Comparing two cashflows

Intertermporal Choice Discount rate Discount factor Magic formulas

Borrower, Lender? Savings

Borrower, Lender? Savings

Consumption Smoothing

Consumption Tilting