L10 Buying and Selling: Applications

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

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

Intertemporal Choice

Many Periods u Cashflows

Many Periods u Cashflow u E: T=3, r=100%. Choose: $1 in each of the three period or $8 in the third

u Gives constant payment x forever u Cashflow Important cashflow: Perpetuity

u You can rent an apartment for $1000 each month (r=0.5%=0.005) u You can buy it P= u Renting vs buying? Perpetuity (Example)

u Valuate a consol that pays $10,000 per year. (r=5%=0.05) u You inherit $1000,000. How much monthly interest are you going to get ? (r=5%=0.05) Perpetuity (Example)

u “Tree” that gives constant payment in T following periods u Cashflow Important cashflow: Annuity

u Leasing or buying a car? Lease T=3, x=$800, r=100% or buy P=750 u Take a loan (how much do you pay monthly) Loan=1000, T=3, r=100% and x=? Leasing or Buying A Car

u Treasury bill: Face, Coupon, Maturity u PV of T-bills (F, c, T) and r Asset Valuation: Bonds

u T-bond (F=100, c=10, T=6) and r=5% Asset Valuation: Example

u Consumption – savings problem u Pension: –How much to put aside? –How much am I going to get? Life cycle problems

u Income: m=100 in the first 60 years u Consumption C during 80 years, u Constant consumption! Find C if r=5% Consumption Smoothing

u You want C=100 when retired (61-80) u How much do you have to save if r=5%, Pension Plan

u You save S=100 (21-60) u How much will you get (per year) if r=5%, Pension Plan