Ch3 Microeconomics Flashcards
(13 cards)
What is the setting studied in this chapter?
A Robinson-Crusoe economy with one agent, one good, two time periods (t=0 and t=1), and a focus on intertemporal decisions involving storage, production, and capital markets.
What are the key elements of the Robinson-Crusoe economy?
One rational agent, one consumption good, initial endowments at t=0 and t=1, and utility maximization over time.
What is time-additive utility?
Utility is the sum of utility from consumption at different times, expressed as U(C0,C1) = u(C0) + β·u(C1), with β in (0,1).
What are common utility functions used in intertemporal models?
Power utility, logarithmic utility, quadratic utility, exponential utility, and hyperbolic absolute risk aversion utility.
What is the consumption optimum with storage only?
The point where the marginal rate of substitution (MRS) between C0 and C1 equals 1.
What role does the production function play?
It introduces investment decisions and determines output based on investment level I.
What is the marginal rate of return in the production function?
It is the derivative of the production function: φ(I) = d(f(I))/dI - 1.
How is the consumption optimum with production determined?
At the point where 1 + φ(I) = MRS = (dU/dC0) / (dU/dC1).
What effect does the capital market have?
It increases the attainable consumption set and allows optimal consumption smoothing via borrowing/lending.
How are decisions separated in the full model with production and capital market?
Into a production decision (based on returns and interest rate) and a consumption decision (based on individual preferences).
What is the Fisher Separation Theorem?
It states that investment decisions can be made independently of individual preferences, just based on objective criteria.
Why is the Fisher Separation Theorem important for corporate finance?
It justifies the separation of ownership (shareholders) and control (managers) in corporations.
Does the Fisher Separation Theorem hold with heterogeneous preferences?
Yes, it still applies when investors have different time preferences.
