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ui (C1 )
MRS i
MRS 01A MRS 01B
ui (C0 ) u B
01
rA rB
(1 ri )
A.Consumption and investment
without capital markets
2) Production
A.Consumption and investment
without capital markets
MRT: MRT increasing:
ui [W ( I1 )]
MRT01i MRT01A MRT01B
ui [W ( I 0 )] B
(1 ri ) rA rB
A.Consumption and investment
without capital markets
3) Optimal consumption
u0 ? Point A : MRT A MRS A invest more
Point E : MRT E MRS E invest less
u1 ? Point B : u (C0 B , C1B ) u (C0 A , C1 A ), but
MRS B MRT B invest more
Point D : u (C0 D , C1D ) u (C0 E , C1E ), but
MRS D MRT D invest less
u2 (Yes!), Point C : Optimal consumption
u (C0C , C1C ) u (C0 D , C1D ) u (C0 B , C1B )
MRS C MRTC
Optimal consumption at (C0C , C1C )
A.Consumption and investment
without capital markets
1) Optimal consumption for different investors
1
MRS 01 MRT011 MRS 01
2
MRT012
Individual 1 prefers consuming more at C1
Individual 2 prefers consuming more at C0
B.Consumption and investment
with capital markets
1. Assumptions
1) All outcomes from investment are known
with certainty.
2) Inter-temporal exchange rate of consumption
bundles, r>0 is known. No transaction costs.
3) No taxes.
4) Two-period model
B.Consumption and investment
with capital markets
2. Optimal consumption with capital markets
1) consumption
B.Consumption and investment
with capital markets
A. Initial endowment, A:
y1
w0 y0
1 r
B. Capital market line (CML)
C. Slope of u0 at A=-(1+ri)
Slope of CML=-(1+r)
r ri A B , Invest more consume less at C0
u1 u0
B.Consumption and investment
with capital markets
*
y1 c
w0 y0 c0* 1
1 r 1 r
c1* w0 (1 r ) c0* (1 r )
w1 c0* (1 r )
intercept slope
w (unchanged), u:u0→u1(↑)
B.Consumption and investment
with capital markets
2) Production
A: Personal
i
MRS 01 MRT01i (1 ri )
B: Market
-(1+r)
B.Consumption and investment
with capital markets
3) Optimal consumption
B.Consumption and investment
with capital markets
A. Initial endowment, A(c0,c1)
MRS 01 i
MRT01i
Invest more at t=0
(or consume less at t=0)
A→B,
u (c0* , c1* ) u (c0 , c1 )
(c0 , c1 ) (c0* , c1* )
where c0 , c1 , w unchanged
(why ?)
B.Consumption and investment
with capital markets
B. Optimal consumption without capital markets, B ( c0* , c1* )
ri>r
markets offer cheaper funds
invest less at t=0
consume more at t=0
borrow more to consume
B→C, u( c** , c** ) u( c* , c* )
0 1 0 1