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Understanding Inter-temporal Choice Theory for Savings and Borrowing

Explore the concept of inter-temporal choice theory in economics, focusing on the implications for savings and borrowing decisions over time. Learn how changes in interest rates affect individual preferences and behaviors, and the interplay between present consumption and future planning. Delve into optimizing decisions and understanding the effects of substitution and income on borrowing and saving behaviors.

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Understanding Inter-temporal Choice Theory for Savings and Borrowing

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  1. Topic 1 Lecture 10 Applications of Consumer Choice Theory 2. Inter-temporal Choice Think of an ‘Endowment Point’ and add it to the diagram. I1 ,C1 I0 , C0 Robin Naylor, Department of Economics, Warwick

  2. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Saving take you? (And then Borrowing?) I1 ,C1 E I1 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  3. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Saving take you? I1 ,C1 E I1 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  4. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Saving take you? I1 ,C1 1+i E I1 1 I0 I0 , C0 One Euro saved this period yields one Euro plus (one Euro times the rate of interest) next period. Or . . . Robin Naylor, Department of Economics, Warwick

  5. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Saving take you? I1 ,C1 C1 I1 E C0 I0 I0 , C0 Or . . . Robin Naylor, Department of Economics, Warwick

  6. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Saving take you? What is the slope of the budget constraint? I1 ,C1 C1 I1 E C0 I0 I0 , C0 Or . . . Robin Naylor, Department of Economics, Warwick

  7. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can Borrowing take you? I1 ,C1 I1 E C1 I0 C0 I0 , C0 Or . . . Robin Naylor, Department of Economics, Warwick

  8. Topic 1 Lecture 10 Inter-temporal Choice From the Endowment Point, where can all possible Saving or Borrowing take you? This is the inter-temporal budget constraint. I1 ,C1 E I1 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  9. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 What is the value of C1? (Note the value of the slope.) C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  10. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 Re-arranging: C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  11. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 C1 E I1 This is the horizontal intercept of the budget constraint. What is its interpretation? C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  12. Topic 1 Lecture 10 Inter-temporal Choice How would you show the effect on the inter-temporal budget constraint of a fall in the rate of interest? I1 ,C1 C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  13. Topic 1 Lecture 10 Inter-temporal Choice What happens to the Present Value of E after a fall in the rate of interest? I1 ,C1 C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  14. Topic 1 Lecture 10 Inter-temporal Choice How would you represent an individual’s preferences over consumption today and tomorrow? I1 ,C1 E I1 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  15. Topic 1 Lecture 10 Inter-temporal Choice What does the slope of the indifference curve represent? If the MRTP is high (low), what does this mean? I1 ,C1 E I1 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  16. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 Optimisation. I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  17. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 Is this person saving or borrowing? I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  18. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 How will they respond to a fall in the rate of interest? What is your intuition? Note: borrowing is cheaper . . . I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  19. Topic 1 Lecture 10 Inter-temporal Choice I1 ,C1 How will they respond to a fall in the rate of interest? Consider the substitution effect. I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  20. Topic 1 Lecture 10 Inter-temporal Choice 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? I1 ,C1 I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  21. Topic 1 Lecture 10 Inter-temporal Choice 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? I1 ,C1 I1 E C1 A B I0 C0 ‘S’ ‘I’ I0 , C0 Robin Naylor, Department of Economics, Warwick

  22. Topic 1 Lecture 10 Inter-temporal Choice So fall in the rate of interest leads Borrower to borrow more: unless Consumption today is a . . . . ‘?’ Good. I1 ,C1 I1 E C1 A B I0 C0 ‘S’ ‘I’ I0 , C0 Robin Naylor, Department of Economics, Warwick

  23. Topic 1 Lecture 10 Inter-temporal Choice 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? I1 ,C1 I1 E C1 A I0 C0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  24. Topic 1 Lecture 10 Inter-temporal Choice 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? I1 ,C1 A C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

  25. Topic 1 Lecture 10 Inter-temporal Choice 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? I1 ,C1 A C1 E I1 C0 I0 I0 , C0 Robin Naylor, Department of Economics, Warwick

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

  27. Topic 1: Lecture 10 Now read B&B 4th 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) Robin Naylor, Department of Economics, Warwick

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