Microeconomics Seminar Questions 6 PDF

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Intermediate (2nd Year) Microeconomics Seminar/Tutorial Questions...

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Seminar Question Sheet 6 Intermediate Microeconomics BIE0008 To be discussed in the tutorial on 02/11/2017. Essential reading for this week is Chapter 20 in John Hey (2003) Intermediate Microeconomics, or Chapter 10 in Hal Varian Intermediate Microeconomics (you can use any edition from 2010 onward, including the ones titled “...with calculus”, “... a modern approach”, “...international student edition” etc.)

Exercise 1: Intertemporal Budget Constraint. 1.1. Suppose you are paid £1200 on the 1st of November and £1000 on the 1st of December. What are the maximum and minimum amounts you can spend in November and December, if you can’t borrow money, but can set some of your November income aside for consumption in December? 1.2. Now suppose you can save and borrow money at the same interest rate 0.0425% (r=0.000425). Plot your intertemporal budget constraint on the (c1 , c2 ) plane. What does a point on this plane mean? Can you consume below, or above the constraint? Mark the endowment point, as well as the sections of the constraint corresponding to borrowing and lending (saving). 1.3. What happens to the intertemporal budget constraint when the interest rate changes? Does it become steeper or flatter when the interest rate rises? Suppose the interest was 0.037% (r=0.00037) one year ago. If a consumer was a borrower a year ago, will she remain a borrower, and will she be better off under the current rate? If she was a lender, will she remain a lender, and will she be better off?

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Exercise 2: Discounted Utility Model. 2.1. Suppose Bob discounts future payoffs at 5% per month. That is, his discount factor is equal to 0.95 (δ = 0.95). Which option would he prefer, in each of the following cases: 1. £100 today or £105 in a month? 2. £100 today or £115 in two months? 3. £100 today or £150 in a year? 4. £100 today or £200 in a year?

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