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Workshop 2 Questions: Exercise 1 (From Lecture Slides)

The document contains 4 exercises that ask the reader to solve multi-period consumption and investment problems for agents with different preferences and endowments. Exercise 1 contains 5 questions that analyze an agent with income of £4 and £6 in periods 1 and 2, log utility, and no time preference discounting in a setting with and without investment and capital market access. Subsequent exercises modify the agent's preferences, endowments, discount factors, production possibilities, and ask the reader to redo parts of Exercise 1.

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Omar Srour
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43 views2 pages

Workshop 2 Questions: Exercise 1 (From Lecture Slides)

The document contains 4 exercises that ask the reader to solve multi-period consumption and investment problems for agents with different preferences and endowments. Exercise 1 contains 5 questions that analyze an agent with income of £4 and £6 in periods 1 and 2, log utility, and no time preference discounting in a setting with and without investment and capital market access. Subsequent exercises modify the agent's preferences, endowments, discount factors, production possibilities, and ask the reader to redo parts of Exercise 1.

Uploaded by

Omar Srour
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Workshop 2 Questions

We consider that the utility of lifetime consumption for agent i is given by Ui (C0 , C1 ) = U (C0 ) +
ρi U (C1 ), where ρi ∈ [0, 1] denotes the agent’s discount factor which measures the agent’s impatience.

Exercise 1 (from Lecture slides)


Agent 1 lives for two periods indexed by t = {0, 1} and earns income y0 = £4 and y1 = £6
in periods 1 and 2, respectively. The agent consumes Ct in period t and consumption
preferences are represented by the utility function U (Ct ) = ln Ct . The agent does not
discount utility from consumption in period 2 (i.e. ρ = 1). The real interest rate is
r = 0.25 and the Production Possibilities Schedule is given by C02 + C12 − 52 ≤ 0.

1. Compute the agent’s lifetime utility in the absence of investment possibilities and
a Capital Market.

2. In the presence of a Capital Market and ignoring the available investment possibil-
ities:

(a) Compute the present value and future value of the agent’s lifetime endowed
wealth.
(b) Compute the consumption allocation that maximises the agent’s lifetime utility
from consumption and the associated lifetime utility. Use a diagram to illustrate
your answer.
(c) Determine whether the individual is a borrower or a lender and compute the
amount that has been borrowed/lent at t = 0 and the amount that has to be
paid/received in period t = 1.

3. In the presence of investment possibilities but without a Capital Market, compute


the optimal consumption allocation and the associated lifetime utility. Illustrate
your answer on the previous graph.

4. In the presence of investment possibilities and a Capital Market, determine the


agent’s optimal consumption and production allocations and the associated lifetime
utility.

5. Consider agent 2 who faces the same investment opportunities, has the same endow-
ment and preferences as agent 1. Agent 2 is more impatient than agent 1 as he/she
discounts utility from consumption in period 2 by a a factor ρ = 0.5. Determine
agent 2’s optimal consumption allocation and production allocation in the presence
of investment possibilities and a Capital Market. How he/she compares to agent 1?

Exercise 2
Suppose that Agent 1 earns income y0 = £5 and y1 = £4 in periods 1 and 2, respectively.
The
√ agent’s consumption preferences are represented by the utility function U (Ct ) =
Ct and he/she discounts utility from consumption in period 2 by a factor ρ = 0.5.
The real interest rate is r = 0.15 and the Production Possibilities Schedule is given by
C02 /2 + C12 − 28.5 ≤ 0.
Redo all questions of Exercise 1 apart from Question 5.

1
Exercise 3
Redo all questions of Exercise 1 apart from Question 5 for the following information:
y0 = £10 and y1 = £12, U (Ct ) = ln Ct where ρ = 0.8, r = 0.1 and C02 + C12 /3 − 148 ≤ 0.

Exercise 4
Redo all questions of Exercise√ 1 apart from Question 5 for the following information:
y0 = £4 and y1 = £8, U (Ct ) = Ct /2 where ρ = 0.8, r = 0.1 and C0 + C12 − 80 ≤ 0.
2

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