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Maximizing Value in Economics: A Comprehensive Guide to Investment Strategies

This course, led by Professor Marshall, delves into the principles of value maximization in economics, covering real and financial investments, cash flow valuation, and the separation principle. Students will learn essential concepts such as optimization, equivalence, and aggregation through real-world applications and problem-solving strategies. Fundamental terminology and concepts will be explored, including the distinction between physical and financial capital, and the importance of time in investment decisions. Prior knowledge of economics and statistics is recommended.

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Maximizing Value in Economics: A Comprehensive Guide to Investment Strategies

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  1. Value Maximization Economics 134A

  2. Prerequisites • PSTAT 5E, Economics 100AB or 104AB, Econ 101 or permission. • Otherwise, see Marshall in office hours for permission to enroll. Tuesday-Wednesday 1-2, NH 3044.

  3. Course web page • www.econ.ucsb.edu/~marshall

  4. Start immediately to learn a spread sheet.

  5. Key concepts of problem solving • Equivalence (usually in present value, occasionally in rate of return) • Optimization (choice of action) • Aggregation (of values of cash flows)

  6. Webservice.com • Example of valuation for a start-up

  7. Key concepts for today • Real investment • Financial investment • Separation principle

  8. Terminology • Real investment = buying physical capital • Financial investment = trading one asset for another • e.g., money for shares of stock

  9. Principle of separation • Present discounted value the real investment. (equivalence). • Decide whether to undertake it (optimization). • Select the appropriate financial investment or disinvestment (optimization).

  10. Time zero is the present • Time one is the future. • Notation: • Cash flows at times zero, one • Prices of those cash flows in current dollars.

  11. Interest rate defined • Premium for current delivery

  12. Interest rate defined • Price of future money in terms of current money

  13. Interest rate applied • Prices of future dollars in terms of current dollars.

  14. Review question • A standard question for midterm or final: Suppose the owner of a firm has a good investment opportunity that uses all of her cash. She wants to consume right away. Which should she do? Explain. • Answer: do both.

  15. Demonstration: Monty Hall • A prize is behind one of three doors. • Contestant chooses one. • Host opens a door that is not the chosen door and not the one concealing the prize. (He knows where the prize is.) • Contestant is allowed to switch doors.

  16. Solution • The contestant should always switch. • Why? Because the host has information that is revealed by his action.

  17. Representation switch and win or stay and lose guess wrong Nature’s move, plus the contestant’s guess. pr = 2/3 pr = 1/3 guess right switch and lose or stay and win

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