Capital

Question 1

What is the marginal rate of time preference

Answer 1

• The future consumption a consumer would exchange for 1 unit of consumption now
• The slope of the IC

Question 2

At the optimal intertemporal point of tangency what two things are equal

Answer 2

Marginal rate of time preference and 1+I (slope of BC)

Question 3

What is diagram for a saver

Answer 3

Where M1> C1

Question 4

Explain how this shows patience and impatience

Answer 4

• The patient consumer decides to delay most of his consumption to period 2 where the impatient consumer decides to consume most now

Question 5

Explain the impact of a fall in interest rates for a borrower/saver

Answer 5

-For both the substitution effect is to increase current consumption and reduce future consumption
- Borrower- Income effect is positive after an interest rate falls so consumes more in both period
- A saver has less income after interest rate fall so her income effect is to consume less in both periods

Question 6

In summary if IR fall what happens

Answer 6

Substitution effect for both is to consume more now
Income effect for saver is to consume less in both period
Income effect for borrower is to consume more in both periods.

Question 7

Explain using the diagram, why permanent not current income determines consumption

Answer 7

• Student at B, professor at C
• With the same preferences they could both consume at C
• the net present value of their income stream M1+ M2/1+I determines their consumption

Question 7

KEY thing to remember about rising and falling IRs on diagram

Answer 7

• Pivot about the endowment point
• Steeper for IR rise and less steep for IR fall