1. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Applications of Consumer Choice Theory 2.Inter-temporal Choice I 1, C 1 I 0, C 0 Think of an ‘Endowment Point’ and add it to the diagram. 1

2. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 From the Endowment Point, where can Saving take you? (And then Borrowing?) E I0I0 I1I1 2

3. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 From the Endowment Point, where can Saving take you? E I0I0 I1I1 3

4. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 From the Endowment Point, where can Saving take you? E One Euro saved this period yields one Euro plus (one Euro times the rate of interest) next period. Or... I0I0 I1I1 1 1+i 4

5. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 From the Endowment Point, where can Saving take you? E Or... I0I0 I1I1 C0C0 C1C1 5

6. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 From the Endowment Point, where can Saving take you? What is the slope of the budget constraint? E Or... I0I0 I1I1 C0C0 C1C1 6

7. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 From the Endowment Point, where can Borrowing take you? E Or... I0I0 I1I1 C0C0 C1C1 7

8. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 From the Endowment Point, where can all possible Saving or Borrowing take you? This is the inter-temporal budget constraint. E I0I0 I1I1 8

9. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 What is the value of C 1 ? (Note the value of the slope.) E I0I0 I1I1 C1C1 C0C0 9

10. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 Re-arranging: E I0I0 I1I1 C1C1 C0C0 10

11. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 This is the horizontal intercept of the budget constraint. What is its interpretation? E I0I0 I1I1 C1C1 C0C0 11

12. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 How would you show the effect on the inter- temporal budget constraint of a fall in the rate of interest? E I0I0 I1I1 C1C1 C0C0 12

13. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 What happens to the Present Value of E after a fall in the rate of interest? E I0I0 I1I1 C1C1 C0C0 13

14. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 How would you represent an individual’s preferences over consumption today and tomorrow? E I0I0 I1I1 14

15. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 What does the slope of the indifference curve represent? If the MRTP is high (low), what does this mean? E I0I0 I1I1 15

16. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 Optimisation. E I0I0 I1I1 A C0C0 C1C1 16

17. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 Is this person saving or borrowing? E I0I0 I1I1 A C0C0 C1C1 17

18. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 How will they respond to a fall in the rate of interest? What is your intuition? Note: borrowing is cheaper... E I0I0 I1I1 A C0C0 C1C1 18

19. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 How will they respond to a fall in the rate of interest? Consider the substitution effect. E I0I0 I1I1 A C0C0 C1C1 19

20. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 Borrowing is cheaper and so the borrower borrows more (Substitution effect). They are also better off (why?): so there is an Income effect. Which way does Income effect go? E I0I0 I1I1 A C0C0 C1C1 20

21. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 Borrowing is cheaper and so the borrower borrows more (Substitution effect). They are also better off (why?): so there is an Income effect. Which way does Income effect go? E I0I0 I1I1 A C0C0 C1C1 ‘S’‘I’ B 21

22. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 So fall in the rate of interest leads Borrower to borrow more: unless Consumption today is a.... ‘?’ Good. E I0I0 I1I1 A C0C0 C1C1 ‘S’‘I’ B 22

23. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 How would you show the effect on a Borrower of a rise in the interest rate? Will the Borrower borrow more or less? On what does your answer depend? E I0I0 I1I1 A C0C0 C1C1 23

24. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 How would you show the effect on a Saver of a rise in the interest rate? Will the Saver save more or less? On what does your answer depend? E I0I0 I1I1 A C0C0 C1C1 24

25. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Inter-temporal Choice I 1, C 1 I 0, C 0 How would you show the effect on a Saver of a fall in the interest rate? Will the Saver save more or less? On what does your answer depend? E I0I0 I1I1 A C0C0 C1C1 25

26. Robin Naylor, Department of Economics, Warwick Topic 1 Lecture 10 Intertemporal Choice 26

27. Robin Naylor, Department of Economics, Warwick Topic 1: Lecture 10 27 Now read B&B 4 th Ed., pp. 126-130; 144-149 (but don’t worry about issues (especially the mathematical material) which go beyond what you have seen in lecture notes or seminar exercise sheets)