Chapter 22: Exchange in Capital Markets
|
|
- Gabriella Payne
- 7 years ago
- Views:
Transcription
1 Chapter 22: Exchange in Capital Markets 22.1: Introduction We are now in a position to examine trade in capital markets. We know that some people borrow and some people save. After a moment s reflection you will also realise that the total amount borrowed must equal the total amount saved if someone wants to borrow some money there must be someone else willing to lend him or her that money. In a capital market which is in equilibrium the price of borrowing and saving must adjust so that borrowing and saving are equal. And what is this price? The rate of return 1+r of course for every 1 borrowed today (1+r) must be repaid in one period s time; for every 1 saved there is a payoff of (1+r) in one period s time. We are assuming there is no inflation 1. This chapter looks at trade through time. We examine a capital market in which individuals can exchange money today for money in one period s time. This may be a bit confusing as what we put on the axes is consumption in the two periods so we should explain a little more what it is that we are assuming. We are assuming that the individuals get utility out of what they consume each period. Consumption is an all-inclusive term but it may simplify things a bit if we think of it as food. So the individuals get utility out of consuming food each period. As we shall assume, they each get an endowment of food each period when they wake up in period 1 there is an endowment of food waiting for them and when they wake up in period 2 there is an endowment of food waiting for them. If they did no trading then they would simply consume the food with which they were endowed and that would be the end of it. However they might prefer to re-arrange their consumption consuming more in one period and less in the other. (For example if they were given lots in one period and very little in the other.) Now suppose that food is perishable so that if it is not consumed in period 1 it goes bad so it can not be consumed in the second period. If that is so then the only way to re-arrange consumption is to trade with someone else A gives some food to B in period 1, for example, and B gives some food to A in period 2. Trade is thus essential if any kind of re-arrangement is to be implemented if the endowment is in perishable food. Now introduce money into the economy and for the moment let us suppose that the price of consumption in both periods is 1 (that is, we are assuming zero inflation). Then money and consumption are synonymous and if we put consumption in period 1 on the horizontal axis it is just the same as if we put money spent in period 1 on the horizontal axis. Similarly, if we put consumption in period 2 on the vertical axis it is just the same as if we put money spent in period 2 on the vertical axis. Now trade on this interpretation is trading money in period 1 for money in period 2. So, for example, A gives some money to B in period 1 and in exchange B gives A some money in period 2. So far so good. The only problem with this interpretation is that money is not like perishable food in a world with no inflation in fact 1 in period 1 remains 1 in period 2. It is therefore clear that no-one will accept a trade which gives them less than 1 in period 2 for each 1 given in period 1. No-one will accept a negative rate of interest as they can always guarantee themselves a zero rate of interest by simply saving the money under the bed 2. So we should be a little careful if we use non-perishable money on the axes rather than perishable food/consumption 1 See later for the differences if there is inflation. 2 If there is inflation say of x% - no-one will accept a rate of interest less than x% because they can once again guarantee a rate of interest equal to x% by saving their money under the bed.
2 on the axes we should check that the equilibrium rate of interest is positive 3. If it is not then the lenders will choose not to lend and will save their money under the bed. 22.2: Trade in a Capital Market We use the technique for analysing exchange that we introduced in chapter 8 that of the Edgeworth box. We assume a very simple economy consisting of just two people and two goods. The people are individuals A and B; the goods are consumption in period 1 and consumption in period 2. The individuals may or may not differ in their preferences over these two goods and they may or may not differ in their endowments of the two goods. Let us build up a specific example, exactly as we did in chapter 8. We start with individual A and assume that initially he or she has 100 units of consumption in period 1 and 25 units in period 2. This is rather an unbalanced endowment and he or she may well be happy to trade to a more balanced consumption profile. Let us suppose that he or she has Discounted Utility preferences with a square root utility function (as we used in chapter 21) and a discount rate ρ equal to 0.3: A discounts the future at 30%. We draw A s indifference curves and endowment point in figure Note that there are lots of points in this figure which A would prefer to his or her endowment point E. Now individual B. I assume that initially he or she has 50 units of consumption in period 1 and 75 units in period 2. He or she too has a somewhat unbalanced initial stock. As for preferences let us assume that B has the same preferences as A Discounted Utility Model preferences with a square root utility function and a discount rate ρ equal to 0.3 so that we can see whether trade is possible when the individuals have the same tastes. B is portrayed in figure 22.2 measured from the usual origin and again in figure 22.3 measured from the top right origin. 3 If there is inflation we should check that the equilibrium real rate of interest is positive.
3 We now do Edgeworth s clever trick. We put the figure of B upside down on top of A the right way up making sure that the endowment points coincide - and we get the Edgeworth box of figure Note very carefully that the width of the box is the total initial stock of consumption in period 1: A has 100 units and B has 50, giving a total of 150 units. The height of the box is the total initial stock of consumption in period 2: A has 25 units and B has 75 units, giving a total of 100 units. We ask whether trade is possible. In figure 22.4 we have not drawn the contract curve but it is drawn in figure 22.9 below. Its position, however, is obvious it is the straight line joining the two origins (because the preferences are identical 4 ). The contract curve has the same interpretation as in chapter 8: it is the locus of efficient points in the space. Any point off the curve is inefficient in the sense that there is always a direction to move in which both individuals are better off than before. However, once on the contract curve any movement is bound to make at least one of the two worse off. We might therefore expect that any contract entered into would be on the contract curve. From the picture it will be seen that the initial point is off the contract curve. In this example the contract curve is the straight line joining the two origins the reason for this is that they have identical preferences. But note that they do not have identical endowments the endowment point E is not at the middle of the box and indeed is off the contract curve. Some trade should be possible. As before, let us investigate where competitive trading takes the two individuals. As we have already noted the price of consumption in period 1 relative to the price of consumption in period 2 is 1+r - where r is the rate of interest - for the simple reason that every pound consumed in period 1 costs 1+r in terms of period 2 consumption - as that is what could be consumed in period 4 And, strictly speaking, because the preferences we have assumed are homothetic which is a mathematical concept outwith the scope of this course.
4 2 if the pound was not consumed in period 1. So the slope of a budget constraint is (1+r). This, of course, we already knew from the material in chapter 20. Now for each rate of interest r we can draw the budget constraint a line with slope (1+r) passing through the point E and hence find the optimal point for each individual. In this way we can find the price-offer (or the interest-rate offer ) curve for each individual. These are illustrated in figure In this figure the convex curve passing through the endowment point E is the interest-rate offer curve for A and the concave curve passing through E is the interest-rate offer curve for B. The straight line joining the two origins is the contract curve which passes through the point where the two interest-rate offer curves intersect. This is the competitive equilibrium and the line joining it and the endowment point E is the equilibrium budget constraint. Let us study carefully this competitive equilibrium which is almost but not quite at the centre of the box. It is at the point (76.24, 50.83) as measured from the bottom left origin and at the point (73.76, 49.17) as measured from the top right origin. We thus get the following analysis. Initial Allocation Individual A Individual B Society Money/Consumption in period 1 Money/Consumption in period Competitive Individual A Individual B Society Equilibrium allocation Money/Consumption in period 1 Money/Consumption
5 in period 2 Changes between the two Money/Consumption in period 1 Money/Consumption in period 2 Individual A Individual B Society So we get the following exchange: A gives to B units of consumption in period 1 and B gives to A units of consumption in period 2. Note very carefully that A forgoes units of period 1 consumption but gets in return units of period 2 consumption. Looking at it in terms of borrowing and saving, A lends to B in period 1 and gets back from B in period 2. For every unit saved (lent to B) in period 1 A gets back 25.83/23.76 = units in period 2 a rate of return and hence a rate of interest 8.7%. Note that this is positive (which means that A is better off lending the money to A rather than keeping the money under the bed). Note also that the slope of the equilibrium budget constraint the line joining E and the competitive equilibrium is In this equilibrium both individuals re-arrange their consumption stream A ends up consuming less than his first period income (which was big) and in exchange gets more period 2 consumption. B increases his first period consumption but has to pay (interest) for the privilege in terms of having a more than lower second period consumption. The competitive equilibrium rate of interest is positive. You might like to ask yourself whether this is always going to be the case. 22.3: A Different Scenario In this section we look at a different scenario. In this Scenario 2 we assume identical endowments but different preferences. The first of these means the endowment point is at the centre of the box and the second of these means that the contract curve is not the straight line joining the two origins. To be specific we assume identical square root utility functions but different discount factors the ρ for A is equal to 0.1 and that for B equal to 0.5. So both discount the future though B more heavily than A. For this reason the contract curve is above and to the left of the line joining two origins for any given division of period 2 consumption B gets rather more than the equal share of consumption in period 1.
6 Notice where the competitive equilibrium is. The equilibrium interest rate is 5% (the slope of the line joining the endowment point and the competitive equilibrium has slope 1.05). Although the two individuals start out with the same endowment, A is induced by a positive rate of interest to lend some money to individual B the reason being that, relative to A, B prefers to consume in the first period and is willing to pay interest for the privilege. As a consequence A ends up consuming more over the two periods combined. 22.4: Comments You will realise that the analysis of this chapter is very similar to that of chapter 8. In fact it is identical except for nomenclature: instead of two general goods we have consumption in period 1 and consumption in period 2 and trade takes place in the capital market where the individuals exchange money/consumption in period 1 for money/consumption in period 2. The price of period 1 consumption in terms of period 2 consumption is one plus the rate of interest. It follows that all the results of chapter 8 remain relevant including: (1) the general possibility of trade except when the initial point is on the contract curve (which happens if the endowments are identical and the preferences are identical); (2) the efficiency of trade along the contract curve; and (3) the efficiency of the competitive equilibrium. Also remaining relevant is the fact that the competitive equilibrium, and hence the equilibrium rate of interest, depends upon the initial endowments and the preferences. 22.5: Summary
7 We have shown that some kind of intertemporal trade is usually possible, though in a world with no inflation and with non-perishable money the competitive equilibrium may not be implementable because one of the agents prefers to store his or her money under the bed rather than accept a negative rate of interest. Otherwise all the results from chapter 8 (which considered trade in general) remain valid. In a world with inflation we simply correct the rate of interest for the inflation and hence get a real rate of interest - equal to the nominal rate of interest minus the rate of inflation. We get the same kind of result: the equilibrium real rate of interest must be positive to induce both agents to indulge in trade. We have shown that the equilibrium (real) rate of interest depends upon the endowments and the preferences of the individuals. 22.6: How can real rates of interest be negative? You may have noticed that, in certain periods of history, real interest rates have been negative. What do we mean by this? Simply that the rate of inflation exceeds the money rate of interest. Consider the following table, taken from statistics in the UK publication Economic Trends Annual Supplement: Year Retail Price index (1985=100) Implied Rate of Inflation between current year and following year (%) Interest Rate on Treasury Bills (%) Take 1974 for example. Between then and 1975, the retail price index rose 15.9% whilst the rate of interest on Treasury Bills was 11.30%. This means that 100 invested in Treasury Bills in 1974 became worth in However, in could buy 100/36.1 = 3.08 in goods whereas in could buy 100/29.1 = 3.44 in goods; that is, the 100 invested in Treasury Bills was worth 10.4% less in 1975, in terms of its buying power over goods, than in 1974 because of the effect of inflation. Prices rose 15.9% while the interest rate was only 11.30% - implying a negative real rate of interest. Money invested in the capital markets was worth less in 1975 than in 1974 in terms of its buying power over goods. You might well ask: how can this happen?
8 Let us use the analysis of the chapter. The key question is whether the equilibrium rate of interest can be negative. We have, so far, assumed zero inflation, and we will continue to do so for the moment, and add inflation in later. In the chapter we assumed that both individuals put more weight on present consumption than on future consumption. It can be shown that, if this is true, then the equilibrium rate of interest must be positive, whatever the initial endowments. Hence, in order to get a case in which we have a negative rate of interest, we must suppose that one of the two individuals puts more weight on future consumption. Consider the following graph. To produce this figure we have assumed that the rate of discount for Individual A (whose consumption we measure from the bottom left-hand origin) is 0.4 and the rate of discount for Individual B (whose consumption we measure from the top right-hand origin) is 0.4. Note carefully the minus sign. So A puts relative weight (=1/(1+0.4)) on second period consumption, while B puts relative weight (= 1/(1-0.4)) on second period consumption. A cares more about period 1 consumption as we have assumed throughout our analysis - but B cares more about period 2 consumption than period 1 consumption. There is nothing to say that this cannot be the case; perhaps you know individuals who feel that way? The figure shows the consequences. We have assumed in this figure that we have a perfectly symmetric endowment point both individuals have income of 50 of each good in each period. The endowment point is indicated with the letter E, and the competitive equilibrium is at the point where the two price-offer curves and the contract curve intersect at the point labelled C, approximately at (71,31). So in the equilibrium exchange, B gives to A 21 units of consumption in period 1 and A gives in exchange 19 units of consumption in period 2. The slope of the equilibrium budget constraint is thus -19/21 = This, as we know, is equal to (1+r) where r is the rate of interest. We therefore have an equilibrium rate of interest 0.096, that is, - 9.6%. A is happy with this exchange as he or she prefers period 1 consumption, and B is happy with this as he or she prefers period 2 consumption. (Recall that the initial endowment point has equal consumption in both periods for both individuals.)
9 At this stage you could retort that B would not enter into this exchange because rather than give up 21 units of period 1 consumption for just 19 of period 2 consumption, he or she would prefer to put the 21 units of period 1 consumption under the bed and consume it in period 2. If the good is perishable this is clearly not possible if it is perishable food, for example. But if it is money, could he or she not simply put the money under the bed? This might work if money did not change value during the period. But consider the possibility of inflation. Let the price of food in period 1 be p 1 and that in period 2 p 2. Suppose the incomes are in food both individuals have an endowment of 50 units of food in each period, and suppose that food is perishable. Then individual B, in order to carry money over to next period, has to sell some of his or her endowment of food in period 1, and then buy some more food in period 2. How does this change the analysis? Note that money per se has no value and cannot be consumed directly. We repeat the analysis under this scenario and what do we find? There is an equilibrium price ratio between food in the two periods which is clearly such that p 1 /p 2 = 19/21 because the slope of the equilibrium budget line is 19/21. It follows therefore that the price in period 2, p 2, is 21/19 times the price in period 1: there is inflation in the price of food between the two periods. Therefore, putting the money under the bed makes no difference, as it is worth less in period 2. Indeed sufficiently less that if B puts 21 in money under the bed in period 1, it will only buy 19 units of food in period 2 exactly the same solution as if trade takes place between A and B! Of course, if there was some other asset, which kept its value between the two periods (or which fell in value less than money), then B should buy that asset. Otherwise, he or she has to accept a negative rate of interest between the two periods precisely because he or she values consumption more in period 2 than in period 1. This perhaps explains why we observe negative real rates of interest from time to time.
10
Chapter 25: Exchange in Insurance Markets
Chapter 25: Exchange in Insurance Markets 25.1: Introduction In this chapter we use the techniques that we have been developing in the previous 2 chapters to discuss the trade of risk. Insurance markets
More informationChapter 27: Taxation. 27.1: Introduction. 27.2: The Two Prices with a Tax. 27.2: The Pre-Tax Position
Chapter 27: Taxation 27.1: Introduction We consider the effect of taxation on some good on the market for that good. We ask the questions: who pays the tax? what effect does it have on the equilibrium
More informationManagerial Economics Prof. Trupti Mishra S.J.M. School of Management Indian Institute of Technology, Bombay. Lecture - 13 Consumer Behaviour (Contd )
(Refer Slide Time: 00:28) Managerial Economics Prof. Trupti Mishra S.J.M. School of Management Indian Institute of Technology, Bombay Lecture - 13 Consumer Behaviour (Contd ) We will continue our discussion
More information3.2. Solving quadratic equations. Introduction. Prerequisites. Learning Outcomes. Learning Style
Solving quadratic equations 3.2 Introduction A quadratic equation is one which can be written in the form ax 2 + bx + c = 0 where a, b and c are numbers and x is the unknown whose value(s) we wish to find.
More informationCHAPTER 3 CONSUMER BEHAVIOR
CHAPTER 3 CONSUMER BEHAVIOR EXERCISES 2. Draw the indifference curves for the following individuals preferences for two goods: hamburgers and beer. a. Al likes beer but hates hamburgers. He always prefers
More informationOne Period Binomial Model
FIN-40008 FINANCIAL INSTRUMENTS SPRING 2008 One Period Binomial Model These notes consider the one period binomial model to exactly price an option. We will consider three different methods of pricing
More informationChapter 3. The Concept of Elasticity and Consumer and Producer Surplus. Chapter Objectives. Chapter Outline
Chapter 3 The Concept of Elasticity and Consumer and roducer Surplus Chapter Objectives After reading this chapter you should be able to Understand that elasticity, the responsiveness of quantity to changes
More informationElasticity. I. What is Elasticity?
Elasticity I. What is Elasticity? The purpose of this section is to develop some general rules about elasticity, which may them be applied to the four different specific types of elasticity discussed in
More informationStudy Questions for Chapter 9 (Answer Sheet)
DEREE COLLEGE DEPARTMENT OF ECONOMICS EC 1101 PRINCIPLES OF ECONOMICS II FALL SEMESTER 2002 M-W-F 13:00-13:50 Dr. Andreas Kontoleon Office hours: Contact: a.kontoleon@ucl.ac.uk Wednesdays 15:00-17:00 Study
More informationThe labour market, I: real wages, productivity and unemployment 7.1 INTRODUCTION
7 The labour market, I: real wages, productivity and unemployment 7.1 INTRODUCTION Since the 1970s one of the major issues in macroeconomics has been the extent to which low output and high unemployment
More informationCHAPTER 9 Building the Aggregate Expenditures Model
CHAPTER 9 Building the Aggregate Expenditures Model Topic Question numbers 1. Consumption function/apc/mpc 1-42 2. Saving function/aps/mps 43-56 3. Shifts in consumption and saving functions 57-72 4 Graphs/tables:
More information4. Answer c. The index of nominal wages for 1996 is the nominal wage in 1996 expressed as a percentage of the nominal wage in the base year.
Answers To Chapter 2 Review Questions 1. Answer a. To be classified as in the labor force, an individual must be employed, actively seeking work, or waiting to be recalled from a layoff. However, those
More informationThe fundamental question in economics is 2. Consumer Preferences
A Theory of Consumer Behavior Preliminaries 1. Introduction The fundamental question in economics is 2. Consumer Preferences Given limited resources, how are goods and service allocated? 1 3. Indifference
More informationProblem Set #5-Key. Economics 305-Intermediate Microeconomic Theory
Problem Set #5-Key Sonoma State University Economics 305-Intermediate Microeconomic Theory Dr Cuellar (1) Suppose that you are paying your for your own education and that your college tuition is $200 per
More informationAK 4 SLUTSKY COMPENSATION
AK 4 SLUTSKY COMPENSATION ECON 210 A. JOSEPH GUSE (1) (a) First calculate the demand at the original price p b = 2 b(p b,m) = 1000 20 5p b b 0 = b(2) = 40 In general m c = m+(p 1 b p0 b )b 0. If the price
More informationThe Mathematics 11 Competency Test Percent Increase or Decrease
The Mathematics 11 Competency Test Percent Increase or Decrease The language of percent is frequently used to indicate the relative degree to which some quantity changes. So, we often speak of percent
More informationTable of Contents MICRO ECONOMICS
economicsentrance.weebly.com Basic Exercises Micro Economics AKG 09 Table of Contents MICRO ECONOMICS Budget Constraint... 4 Practice problems... 4 Answers... 4 Supply and Demand... 7 Practice Problems...
More informationc 2008 Je rey A. Miron We have described the constraints that a consumer faces, i.e., discussed the budget constraint.
Lecture 2b: Utility c 2008 Je rey A. Miron Outline: 1. Introduction 2. Utility: A De nition 3. Monotonic Transformations 4. Cardinal Utility 5. Constructing a Utility Function 6. Examples of Utility Functions
More informationA Model of Housing Prices and Residential Investment
A Model of Prices and Residential Investment Chapter 9 Appendix In this appendix, we develop a more complete model of the housing market that explains how housing prices are determined and how they interact
More informationCommon sense, and the model that we have used, suggest that an increase in p means a decrease in demand, but this is not the only possibility.
Lecture 6: Income and Substitution E ects c 2009 Je rey A. Miron Outline 1. Introduction 2. The Substitution E ect 3. The Income E ect 4. The Sign of the Substitution E ect 5. The Total Change in Demand
More informationChapter 4 Online Appendix: The Mathematics of Utility Functions
Chapter 4 Online Appendix: The Mathematics of Utility Functions We saw in the text that utility functions and indifference curves are different ways to represent a consumer s preferences. Calculus can
More informationDecision Making under Uncertainty
6.825 Techniques in Artificial Intelligence Decision Making under Uncertainty How to make one decision in the face of uncertainty Lecture 19 1 In the next two lectures, we ll look at the question of how
More informationCHAPTER 7: AGGREGATE DEMAND AND AGGREGATE SUPPLY
CHAPTER 7: AGGREGATE DEMAND AND AGGREGATE SUPPLY Learning goals of this chapter: What forces bring persistent and rapid expansion of real GDP? What causes inflation? Why do we have business cycles? How
More informationFinance, Saving, and Investment
23 Finance, Saving, and Investment Learning Objectives The flows of funds through financial markets and the financial institutions Borrowing and lending decisions in financial markets Effects of government
More informationANSWERS TO END-OF-CHAPTER QUESTIONS
ANSWERS TO END-OF-CHAPTER QUESTIONS 9-1 Explain what relationships are shown by (a) the consumption schedule, (b) the saving schedule, (c) the investment-demand curve, and (d) the investment schedule.
More informationExample 1. Consider the following two portfolios: 2. Buy one c(s(t), 20, τ, r) and sell one c(s(t), 10, τ, r).
Chapter 4 Put-Call Parity 1 Bull and Bear Financial analysts use words such as bull and bear to describe the trend in stock markets. Generally speaking, a bull market is characterized by rising prices.
More information1. Briefly explain what an indifference curve is and how it can be graphically derived.
Chapter 2: Consumer Choice Short Answer Questions 1. Briefly explain what an indifference curve is and how it can be graphically derived. Answer: An indifference curve shows the set of consumption bundles
More informationTRADE AND INVESTMENT IN THE NATIONAL ACCOUNTS This text accompanies the material covered in class.
TRADE AND INVESTMENT IN THE NATIONAL ACCOUNTS This text accompanies the material covered in class. 1 Definition of some core variables Imports (flow): Q t Exports (flow): X t Net exports (or Trade balance)
More informationThe Central Idea CHAPTER 1 CHAPTER OVERVIEW CHAPTER REVIEW
CHAPTER 1 The Central Idea CHAPTER OVERVIEW Economic interactions involve scarcity and choice. Time and income are limited, and people choose among alternatives every day. In this chapter, we study the
More information1 Present and Future Value
Lecture 8: Asset Markets c 2009 Je rey A. Miron Outline:. Present and Future Value 2. Bonds 3. Taxes 4. Applications Present and Future Value In the discussion of the two-period model with borrowing and
More informationSolution to Exercise 7 on Multisource Pollution
Peter J. Wilcoxen Economics 437 The Maxwell School Syracuse University Solution to Exercise 7 on Multisource Pollution 1 Finding the Efficient Amounts of Abatement There are two ways to find the efficient
More informationBonds and the Term Structure of Interest Rates: Pricing, Yields, and (No) Arbitrage
Prof. Alex Shapiro Lecture Notes 12 Bonds and the Term Structure of Interest Rates: Pricing, Yields, and (No) Arbitrage I. Readings and Suggested Practice Problems II. Bonds Prices and Yields (Revisited)
More informationThe Keynesian Cross. A Fixed Price Level. The Simplest Keynesian-Cross Model: Autonomous Consumption Only
The Keynesian Cross Some instructors like to develop a more detailed macroeconomic model than is presented in the textbook. This supplemental material provides a concise description of the Keynesian-cross
More information4 THE MARKET FORCES OF SUPPLY AND DEMAND
4 THE MARKET FORCES OF SUPPLY AND DEMAND IN THIS CHAPTER YOU WILL Learn what a competitive market is Examine what determines the demand for a good in a competitive market Chapter Overview Examine what
More informationEC2105, Professor Laury EXAM 2, FORM A (3/13/02)
EC2105, Professor Laury EXAM 2, FORM A (3/13/02) Print Your Name: ID Number: Multiple Choice (32 questions, 2.5 points each; 80 points total). Clearly indicate (by circling) the ONE BEST response to each
More informationModule 49 Consumer and Producer Surplus
What you will learn in this Module: The meaning of consumer surplus and its relationship to the demand curve The meaning of producer surplus and its relationship to the supply curve Module 49 Consumer
More informationSupply and Demand in the Market for Money: The Liquidity Preference Framework
APPENDIX 3 TO CHAPTER 4 Supply and Demand in the arket for oney: The Liquidity Preference Framework Whereas the loanable funds framework determines the equilibrium interest rate using the supply of and
More informationWeek 1: Functions and Equations
Week 1: Functions and Equations Goals: Review functions Introduce modeling using linear and quadratic functions Solving equations and systems Suggested Textbook Readings: Chapter 2: 2.1-2.2, and Chapter
More informationPERPETUITIES NARRATIVE SCRIPT 2004 SOUTH-WESTERN, A THOMSON BUSINESS
NARRATIVE SCRIPT 2004 SOUTH-WESTERN, A THOMSON BUSINESS NARRATIVE SCRIPT: SLIDE 2 A good understanding of the time value of money is crucial for anybody who wants to deal in financial markets. It does
More informationCHAPTER 4 Consumer Choice
CHAPTER 4 Consumer Choice CHAPTER OUTLINE 4.1 Preferences Properties of Consumer Preferences Preference Maps 4.2 Utility Utility Function Ordinal Preference Utility and Indifference Curves Utility and
More informationFISCAL POLICY* Chapter. Key Concepts
Chapter 11 FISCAL POLICY* Key Concepts The Federal Budget The federal budget is an annual statement of the government s expenditures and tax revenues. Using the federal budget to achieve macroeconomic
More informationchapter >> Making Decisions Section 2: Making How Much Decisions: The Role of Marginal Analysis
chapter 7 >> Making Decisions Section : Making How Much Decisions: The Role of Marginal Analysis As the story of the two wars at the beginning of this chapter demonstrated, there are two types of decisions:
More informationVALUE 11.125%. $100,000 2003 (=MATURITY
NOTES H IX. How to Read Financial Bond Pages Understanding of the previously discussed interest rate measures will permit you to make sense out of the tables found in the financial sections of newspapers
More informationI. Introduction to Taxation
University of Pacific-Economics 53 Lecture Notes #17 I. Introduction to Taxation Government plays an important role in most modern economies. In the United States, the role of the government extends from
More informationChapter 2 An Introduction to Forwards and Options
Chapter 2 An Introduction to Forwards and Options Question 2.1. The payoff diagram of the stock is just a graph of the stock price as a function of the stock price: In order to obtain the profit diagram
More informationReview of Fundamental Mathematics
Review of Fundamental Mathematics As explained in the Preface and in Chapter 1 of your textbook, managerial economics applies microeconomic theory to business decision making. The decision-making tools
More informationhp calculators HP 17bII+ Net Present Value and Internal Rate of Return Cash Flow Zero A Series of Cash Flows What Net Present Value Is
HP 17bII+ Net Present Value and Internal Rate of Return Cash Flow Zero A Series of Cash Flows What Net Present Value Is Present Value and Net Present Value Getting the Present Value And Now For the Internal
More informationI d ( r; MPK f, τ) Y < C d +I d +G
1. Use the IS-LM model to determine the effects of each of the following on the general equilibrium values of the real wage, employment, output, the real interest rate, consumption, investment, and the
More informationDEMAND FORECASTING. Demand. Law of Demand. Definition of Law of Demand
DEMAND FORECASTING http://www.tutorialspoint.com/managerial_economics/demand_forecasting.htm Copyright tutorialspoint.com Demand Demand is a widely used term, and in common is considered synonymous with
More informationEcon 202 Final Exam. Table 3-1 Labor Hours Needed to Make 1 Pound of: Meat Potatoes Farmer 8 2 Rancher 4 5
Econ 202 Final Exam 1. If inflation expectations rise, the short-run Phillips curve shifts a. right, so that at any inflation rate unemployment is higher. b. left, so that at any inflation rate unemployment
More informationThe Graphical Method: An Example
The Graphical Method: An Example Consider the following linear program: Maximize 4x 1 +3x 2 Subject to: 2x 1 +3x 2 6 (1) 3x 1 +2x 2 3 (2) 2x 2 5 (3) 2x 1 +x 2 4 (4) x 1, x 2 0, where, for ease of reference,
More informationChapter 4 Consumption, Saving, and Investment
Chapter 4 Consumption, Saving, and Investment Multiple Choice Questions 1. Desired national saving equals (a) Y C d G. (b) C d + I d + G. (c) I d + G. (d) Y I d G. 2. With no inflation and a nominal interest
More informationPracticed Questions. Chapter 20
Practiced Questions Chapter 20 1. The model of aggregate demand and aggregate supply a. is different from the model of supply and demand for a particular market, in that we cannot focus on the substitution
More informationDEMAND AND SUPPLY. Chapter. Markets and Prices. Demand. C) the price of a hot dog minus the price of a hamburger.
Chapter 3 DEMAND AND SUPPLY Markets and Prices Topic: Price and Opportunity Cost 1) A relative price is A) the slope of the demand curve B) the difference between one price and another C) the slope of
More informationInvestment Appraisal INTRODUCTION
8 Investment Appraisal INTRODUCTION After reading the chapter, you should: understand what is meant by the time value of money; be able to carry out a discounted cash flow analysis to assess the viability
More informationchapter >> Consumer and Producer Surplus Section 3: Consumer Surplus, Producer Surplus, and the Gains from Trade
chapter 6 >> Consumer and Producer Surplus Section 3: Consumer Surplus, Producer Surplus, and the Gains from Trade One of the nine core principles of economics we introduced in Chapter 1 is that markets
More informationMULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
Chatper 34 International Finance - Test Bank MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The currency used to buy imported goods is A) the
More informationSolution: The optimal position for an investor with a coefficient of risk aversion A = 5 in the risky asset is y*:
Problem 1. Consider a risky asset. Suppose the expected rate of return on the risky asset is 15%, the standard deviation of the asset return is 22%, and the risk-free rate is 6%. What is your optimal position
More informationMath 1526 Consumer and Producer Surplus
Math 156 Consumer and Producer Surplus Scenario: In the grocery store, I find that two-liter sodas are on sale for 89. This is good news for me, because I was prepared to pay $1.9 for them. The store manager
More information1. a. (iv) b. (ii) [6.75/(1.34) = 10.2] c. (i) Writing a call entails unlimited potential losses as the stock price rises.
1. Solutions to PS 1: 1. a. (iv) b. (ii) [6.75/(1.34) = 10.2] c. (i) Writing a call entails unlimited potential losses as the stock price rises. 7. The bill has a maturity of one-half year, and an annualized
More informationMonetary Policy Bank of Canada
Bank of Canada The objective of monetary policy may be gleaned from to preamble to the Bank of Canada Act of 1935 which says, regulate credit and currency in the best interests of the economic life of
More informationD) surplus; negative. 9. The law of one price is enforced by: A) governments. B) producers. C) consumers. D) arbitrageurs.
1. An open economy is one in which: A) the level of output is fixed. B) government spending exceeds revenues. C) the national interest rate equals the world interest rate. D) there is trade in goods and
More informationANSWERS TO END-OF-CHAPTER PROBLEMS WITHOUT ASTERISKS
Part III Answers to End-of-Chapter Problems 97 CHAPTER 1 ANSWERS TO END-OF-CHAPTER PROBLEMS WITHOUT ASTERISKS Why Study Money, Banking, and Financial Markets? 7. The basic activity of banks is to accept
More informationUse the following to answer question 9: Exhibit: Keynesian Cross
1. Leading economic indicators are: A) the most popular economic statistics. B) data that are used to construct the consumer price index and the unemployment rate. C) variables that tend to fluctuate in
More informationSHORT-RUN FLUCTUATIONS. David Romer. University of California, Berkeley. First version: August 1999 This revision: January 2012
SHORT-RUN FLUCTUATIONS David Romer University of California, Berkeley First version: August 1999 This revision: January 2012 Copyright 2012 by David Romer CONTENTS Preface vi I The IS-MP Model 1 I-1 Monetary
More informationECON 3312 Macroeconomics Exam 3 Fall 2014. Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
ECON 3312 Macroeconomics Exam 3 Fall 2014 Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Everything else held constant, an increase in net
More information7 AGGREGATE SUPPLY AND AGGREGATE DEMAND* Chapter. Key Concepts
Chapter 7 AGGREGATE SUPPLY AND AGGREGATE DEMAND* Key Concepts Aggregate Supply The aggregate production function shows that the quantity of real GDP (Y ) supplied depends on the quantity of labor (L ),
More informationIt Is In Your Interest
STUDENT MODULE 7.2 BORROWING MONEY PAGE 1 Standard 7: The student will identify the procedures and analyze the responsibilities of borrowing money. It Is In Your Interest Jason did not understand how it
More informationChapter 7 Monopoly, Oligopoly and Strategy
Chapter 7 Monopoly, Oligopoly and Strategy After reading Chapter 7, MONOPOLY, OLIGOPOLY AND STRATEGY, you should be able to: Define the characteristics of Monopoly and Oligopoly, and explain why the are
More informationChapter 5. Conditional CAPM. 5.1 Conditional CAPM: Theory. 5.1.1 Risk According to the CAPM. The CAPM is not a perfect model of expected returns.
Chapter 5 Conditional CAPM 5.1 Conditional CAPM: Theory 5.1.1 Risk According to the CAPM The CAPM is not a perfect model of expected returns. In the 40+ years of its history, many systematic deviations
More informationUntangling F9 terminology
Untangling F9 terminology Welcome! This is not a textbook and we are certainly not trying to replace yours! However, we do know that some students find some of the terminology used in F9 difficult to understand.
More informationChapter 21: The Discounted Utility Model
Chapter 21: The Discounted Utility Model 21.1: Introduction This is an important chapter in that it introduces, and explores the implications of, an empirically relevant utility function representing intertemporal
More information6.4 Normal Distribution
Contents 6.4 Normal Distribution....................... 381 6.4.1 Characteristics of the Normal Distribution....... 381 6.4.2 The Standardized Normal Distribution......... 385 6.4.3 Meaning of Areas under
More informationThe Marginal Cost of Capital and the Optimal Capital Budget
WEB EXTENSION12B The Marginal Cost of Capital and the Optimal Capital Budget If the capital budget is so large that a company must issue new equity, then the cost of capital for the company increases.
More informationECON 459 Game Theory. Lecture Notes Auctions. Luca Anderlini Spring 2015
ECON 459 Game Theory Lecture Notes Auctions Luca Anderlini Spring 2015 These notes have been used before. If you can still spot any errors or have any suggestions for improvement, please let me know. 1
More informationChapter 6 Competitive Markets
Chapter 6 Competitive Markets After reading Chapter 6, COMPETITIVE MARKETS, you should be able to: List and explain the characteristics of Perfect Competition and Monopolistic Competition Explain why a
More informationNotes - Gruber, Public Finance Chapter 20.3 A calculation that finds the optimal income tax in a simple model: Gruber and Saez (2002).
Notes - Gruber, Public Finance Chapter 20.3 A calculation that finds the optimal income tax in a simple model: Gruber and Saez (2002). Description of the model. This is a special case of a Mirrlees model.
More informationLinear Programming Notes VII Sensitivity Analysis
Linear Programming Notes VII Sensitivity Analysis 1 Introduction When you use a mathematical model to describe reality you must make approximations. The world is more complicated than the kinds of optimization
More informationICASL - Business School Programme
ICASL - Business School Programme Quantitative Techniques for Business (Module 3) Financial Mathematics TUTORIAL 2A This chapter deals with problems related to investing money or capital in a business
More informationRefer to Figure 17-1
Chapter 17 1. Inflation can be measured by the a. change in the consumer price index. b. percentage change in the consumer price index. c. percentage change in the price of a specific commodity. d. change
More informationI. Introduction to Aggregate Demand/Aggregate Supply Model
University of California-Davis Economics 1B-Intro to Macro Handout 8 TA: Jason Lee Email: jawlee@ucdavis.edu I. Introduction to Aggregate Demand/Aggregate Supply Model In this chapter we develop a model
More informationDemand, Supply, and Market Equilibrium
3 Demand, Supply, and Market Equilibrium The price of vanilla is bouncing. A kilogram (2.2 pounds) of vanilla beans sold for $50 in 2000, but by 2003 the price had risen to $500 per kilogram. The price
More informationChapter 3 Consumer Behavior
Chapter 3 Consumer Behavior Read Pindyck and Rubinfeld (2013), Chapter 3 Microeconomics, 8 h Edition by R.S. Pindyck and D.L. Rubinfeld Adapted by Chairat Aemkulwat for Econ I: 2900111 1/29/2015 CHAPTER
More informationTwo-Period Consumer Model
Two-Period Consumer Model Of the expenditure components in the income-expenditure identity, the largest, by far, is consumption - spending by private households on final goods and services. For 2008, GDP
More information3.1. Solving linear equations. Introduction. Prerequisites. Learning Outcomes. Learning Style
Solving linear equations 3.1 Introduction Many problems in engineering reduce to the solution of an equation or a set of equations. An equation is a type of mathematical expression which contains one or
More informationc. Given your answer in part (b), what do you anticipate will happen in this market in the long-run?
Perfect Competition Questions Question 1 Suppose there is a perfectly competitive industry where all the firms are identical with identical cost curves. Furthermore, suppose that a representative firm
More informationCHAPTER 20 Understanding Options
CHAPTER 20 Understanding Options Answers to Practice Questions 1. a. The put places a floor on value of investment, i.e., less risky than buying stock. The risk reduction comes at the cost of the option
More information1) Write the following as an algebraic expression using x as the variable: Triple a number subtracted from the number
1) Write the following as an algebraic expression using x as the variable: Triple a number subtracted from the number A. 3(x - x) B. x 3 x C. 3x - x D. x - 3x 2) Write the following as an algebraic expression
More informationShares Mutual funds Structured bonds Bonds Cash money, deposits
FINANCIAL INSTRUMENTS AND RELATED RISKS This description of investment risks is intended for you. The professionals of AB bank Finasta have strived to understandably introduce you the main financial instruments
More informationChapter 6: Measuring the Price Level and Inflation. The Price Level and Inflation. Connection between money and prices. Index Numbers in General
Chapter 6: The Price Level and Measuring the Price Level and Microeconomic causes changes in individual markets can explain only a tiny fraction of price change For the most part, price rises came about
More informationMULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
Suvey of Macroeconomics, MBA 641 Fall 2006, Final Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Modern macroeconomics emerged from
More informationDuration Gap Analysis
appendix 1 to chapter 9 Duration Gap Analysis An alternative method for measuring interest-rate risk, called duration gap analysis, examines the sensitivity of the market value of the financial institution
More informationChapter 04 Firm Production, Cost, and Revenue
Chapter 04 Firm Production, Cost, and Revenue Multiple Choice Questions 1. A key assumption about the way firms behave is that they a. Minimize costs B. Maximize profit c. Maximize market share d. Maximize
More information3. Time value of money. We will review some tools for discounting cash flows.
1 3. Time value of money We will review some tools for discounting cash flows. Simple interest 2 With simple interest, the amount earned each period is always the same: i = rp o where i = interest earned
More informationLesson 7 - The Aggregate Expenditure Model
Lesson 7 - The Aggregate Expenditure Model Acknowledgement: Ed Sexton and Kerry Webb were the primary authors of the material contained in this lesson. Section : The Aggregate Expenditures Model Aggregate
More informationPrinciples of Economics: Micro: Exam #2: Chapters 1-10 Page 1 of 9
Principles of Economics: Micro: Exam #2: Chapters 1-10 Page 1 of 9 print name on the line above as your signature INSTRUCTIONS: 1. This Exam #2 must be completed within the allocated time (i.e., between
More informationChapter 6. Commodity Forwards and Futures. Question 6.1. Question 6.2
Chapter 6 Commodity Forwards and Futures Question 6.1 The spot price of a widget is $70.00. With a continuously compounded annual risk-free rate of 5%, we can calculate the annualized lease rates according
More informationMath 120 Final Exam Practice Problems, Form: A
Math 120 Final Exam Practice Problems, Form: A Name: While every attempt was made to be complete in the types of problems given below, we make no guarantees about the completeness of the problems. Specifically,
More informationCapital Structure. Itay Goldstein. Wharton School, University of Pennsylvania
Capital Structure Itay Goldstein Wharton School, University of Pennsylvania 1 Debt and Equity There are two main types of financing: debt and equity. Consider a two-period world with dates 0 and 1. At
More informationECON 443 Labor Market Analysis Final Exam (07/20/2005)
ECON 443 Labor Market Analysis Final Exam (07/20/2005) I. Multiple-Choice Questions (80%) 1. A compensating wage differential is A) an extra wage that will make all workers willing to accept undesirable
More information