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Understanding Buying and Selling Applications: A Review of Intertemporal Choice Models

This review explores various applications of buying and selling, focusing on intertemporal choice models that reveal preferences and demand dynamics. Key applications include labor supply, intertemporal choices related to consumption and savings, and the impact of uncertainty on decisions. We discuss the two-period model of choice involving today's and tomorrow's consumption, highlighting the roles of income, borrowing, and lending. Additionally, we delve into present value (PV) and future value (FV) concepts, budget constraints, and key financial formulas, providing insights into effective consumption smoothing and decision-making.

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Understanding Buying and Selling Applications: A Review of Intertemporal Choice Models

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Presentation Transcript

  1. L9 Buying and Selling: Applications

  2. Review • Model of choice • We know preferences and we find • The two differences – net demands • Buying, selling?

  3. More generally x2 w2 w1 x1

  4. Three Applications 1. Labor Supply (Labor-Leisure Choice) 2. Intertemporal Choice (Consumption-Savings Choice) 3. Uncertainty (Insurance) (Consumption across states of the world)

  5. Intertemporal Choice • Two periods: Today and Tomorrow • Goods: consumtion today and tomorrow • Endowment: income today and income tomorrow • Possibility of borrowing and lending

  6. Intertemporal Choice

  7. Intertemporal Budget Constraint

  8. Present Value (PV) and Future Value (FV) • The interest rate is • FV: Future equivalent of today’s $1 • PV: Today’s equivalent of tomorrows $1 • What is PV and FV of cashflow

  9. Budget constraint (2 versions) • FV of spending = FV of income • PV of spending = PV of income • Prices and income

  10. Comparing two cashflows

  11. Intertermporal Choice • Discount rate • Discount factor • Magic formulas

  12. Borrower, Lender? Savings

  13. Borrower, Lender? Savings

  14. Consumption Smoothing

  15. Consumption Tilting

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