1. Buying and Selling: Applications

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

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

4. Intertemporal Choice

5. Many Periods
Cashflows

6. Many Periods Cashflow E: T=3, r=100%. Choose:
$1 in each of the three period or $8 in the third

7. Important cashflow: Perpetuity
Gives constant payment x forever
Cashflow

8. Perpetuity (Example)
You can rent an apartment for $1000 each month (r=0.5%=0.005)
You can buy it P=
Renting vs buying?

9. Perpetuity (Example)
Valuate a consol that pays $10,000 per year. (r=5%=0.05)
You inherit $1000,000. How much monthly interest are you going to get ? (r=5%=0.05)

10. Important cashflow: Annuity
“Tree” that gives constant payment in T following periods
Cashflow

11. Leasing or Buying A Car Leasing or buying a car?
Lease T=3, x=$800, r=100% or buy P=750
Take a loan (how much do you pay monthly)
Loan=1000, T=3, r=100% and x=?

12. Asset Valuation: Bonds
Treasury bill: Face, Coupon, Maturity
PV of T-bills (F, c, T) and r

13. Asset Valuation: Example
T-bond (F=100, c=10, T=6) and r=5%

14. Life cycle problems Consumption – savings problem Pension:
How much to put aside?
How much am I going to get?

15. Consumption Smoothing
Income: m=100 in the first 60 years
Consumption C during 80 years,
Constant consumption! Find C if r=5%

16. Pension Plan You want C=100 when retired (61-80)
How much do you have to save if r=5%,

17. Pension Plan You save S=100 (21-60)
How much will you get (per year) if r=5%,