sl354, intermediate microeconomics
DESCRIPTION
SL354, Intermediate Microeconomics. Monday. Tuesday. Thursday. Friday. Week 1 : March 3 – 7. Introduction Varian, 1. Budget Constraints Varian, 2. Preferences Varian, 3. Utility Varian, 4. Week 2 : March 10 – 14. Choice Varian, 5. Consumer Demand Varian, 6 [7]. - PowerPoint PPT PresentationTRANSCRIPT
SL354, Intermediate Microeconomics
Week 1 :March 3 – 7
Monday Tuesday Thursday Friday
Exam 1
Exam 2
Exam 3
Exam 4
Exam 5
Problem Set 3
EquilibriumVarian, 16
Problem Set 2
AuctionsVarian, 17
Profit MaximizationVarian, 19
Welfare Varian, 33
ExternalitiesVarian, 34
InformationVarian, 35
IntroductionVarian, 1
Budget ConstraintsVarian, 2
PreferencesVarian, 3
ChoiceVarian, 5
Consumer DemandVarian, 6 [7]
S. & I. EffectsVarian, 8
Buying & SellingVarian, 9
Intertemporal ChoiceVarian, 10; Thaler, 8 – 9
Market DemandVarian, 15
Loss Aversion, etc.Thaler, 6 – 7
Asset MarketsVarian, 11
Risky AssetsVarian, 13
Capital Markets IThaler, 10 – 11
Capital Markets IIThaler, 12 and 14
UtilityVarian, 4
Problem Set 1Thaler, 1 – 3
Uncertainty (Risk)Varian, 12
Problem Set 4
TechnologyVarian, 18
ExchangeVarian, 31
ProductionVarian, 32
General EquilibriumTBD
AuctionsThaler, 5
Asymmetric InformationVarian, 37
Problem Set 5Thaler, 15
Portfolio Theory TBD
Week 2 :March 10 – 14
Week 3 :March 17 – 21
Week 4 :March 24 – 28
Week 5 :April 7 – 11
Week 6 :April 14 – 18
Week 7 :April 21 – 25
Week 8 :April 28 – May 2
Week 9 :May 5 – 9
Week 10 :May 12 – 16
Buying & SellingVarian, 9
1c
Borrowingin period 1
Intertemporal Trades
0I
21 +)+1( mmr
r 1
{ }210 ,= mmE
•
•
21 ccA ,
1C
2C
2m
2c
1m( )r
mm
+1+ 2
1
Intertemporal Trades
1C
2C
21 = CC
1C
2C
21 = CC
Impatient preferences (Positive time preference)
Patient preferences (Negative time preference)
Asset Markets: Debt
Asset Markets: Debt
Asset Markets: Equity
*Calculated from a value-weighted index of all publicly traded stocks using CRSP data.
Average Annual Returns*
-40%
-20%
0%
20%
40%
60%
80%
100%
Jan-
82
Jan-
84
Jan-
86
Jan-
88
Jan-
90
Jan-
92
Jan-
94
Jan-
96
Jan-
98
Jan-
00
Jan-
02
Jan-
04
S&P 500 Index General Electric
*Calculated as compounded annual return on average monthly returns from preceding 12 months.
GE Average1982-200524%
SP500 Average1982-200512.3%
Asset Markets: Equity
The present value (PV) of an amount to be received at time t (FV) when the per-period discount rate is r:
The present value (PV) of a stream of future values, when the per-period discount rate is r:
Bond pricing. The price of a bond will be the net present value of interest payments and the maturity date and value.
Stock valuation. The current value of a firm (PVFirm) is the present value of the stream of future profits that the firm will generate -- and shareholders are “residual claimants” of those profits:
tr
FVPV
1
n
tt
tn
n
r
FV
r
FV
r
FV
r
FVPV
01
10
0
1111
0 1tt
tFirm
rPV
Present Valuation Techniques and Asset Valuation
Optimal Holding Period for an Asset
$0
$50
$100
$150
$200
$250
$300
$350
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Time
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
22%
24%
tFV
tPV
Rate of return from holding asset
t*
Risk and Uncertainty: “Contingent Consumption Plans”
Purchase
Do notpurchase
Luckyday
Unluckyday
$100
$295
$95
Case 1:A person with an endowment of $100 is considering the purchase of a lottery ticket that costs $5. The winning ticket in the lottery gets $200.
Case 2:A person with an endowment of $35,000 faces a 1% probability of losing $10,000. He is considering the purchase of full insurance against the loss for $100.
Purchase
Do notpurchase
Luckyday
Unluckyday
$35,000
$34,900
$34,900
Luckyday
Unluckyday $25,000
995$
900,34$
x
xE
0
900,34$
x
xE
Outcome A:
Outcome B:
31$
100$
x
xE
IfPr(Lucky) = 0.025):
0I
1
00 , bg CCE
•
•
BadC
GoodC
000,35$0 gC
KCC
C
gb
b
00
0 000,25$
KCC
C
gb
g
01
1 900,34$
KKCC
C
bb
b
01
1 900,34$
11 , bg CCA
Risk and Uncertainty: “Contingent Consumption Plans”
Purchase
Do notpurchase
Luckyday
Unluckyday
$35,000
$34,900
$34,900
Luckyday
Unluckyday
$25,000
K = the “expected loss” ($10,000), and K is the insurance premium.
1. Risk aversion is defined through peoples’ choices:
2. Non-linearity in the utility of wealth.
Given a choice between two options with equal expected values anddifferent standard deviations, a risk averse person will choose the optionwith the lower standard deviation:
Given a choice between two options with equal standard deviations anddifferent expected values, a risk-averse person will choose the optionwith the higher expected value:
212121 then , and ,XEXE If
212121 then ,XEXE and , If
Economic Treatment of Risk The Meaning of Risk Aversion
Pr(xB) = .010
$100,000
$50,000
E[X] = $99,500= $4,975cv = 0.0500
Pr(xA) = .990
Dealing With Risk: Insurance
Pr(xB) = .010
$100,000
$100,000 - $500
$99,500
E[X] = $99,500= $0cv = 0
Pr(xA) = .990
$100,000 - $500 - $50,000 + $50,000
$99,500
Dealing With Risk: Insurance
E[X] = $99,500= $0cv = 0
IsPreferable
to
E[X] = $99,500= $4,975cv = 0.0500
For a risk-averse person . . .
IsEquivalent
to
E[X] = $99,500= $4,975cv = 0.0500
Can we find another option, keeping = $0, but with a lowerE[X], that will be considered equal to the original? For example,suppose that for this risk-averse person . . .
E[X] = $99,415= $0cv = 0
Dealing With Risk: Insurance
If, for a risk-averse person . . .
IsEquivalent
to
E[X] = $99,500= $4,975cv = 0.0500
Then $99,415 is called a certainty equivalent.
$99,415
Furthermore, we will be able to sell an insurance policy to thisperson for $585.
The $85 difference between the amount the person will pay andthe expected loss is called a risk premium.
Dealing With Risk: Insurance
$99,415
B
Risk Premium
500,99415,99$2 UEUU
$
Utility
$100,000$0
U1
A
C
U3
$50,000
000501 ,$UU 0001003 ,$UU
U($)
$99,500
U2 D
Economic Treatment of Risk The Meaning of Risk Aversion
$
Utility
U($)
Economic Treatment of Risk Risk Aversion and Risk Neutrality U($)
U($)
Risk Aversi
on
Risk Seeking
Risk Neutra
l
Risk Premium 2
$
Utility
U2($)
Economic Treatment of Risk Risk Tolerance
U1($)
Risk Premium 1
Risk Premium 1 > Risk Premium 2 : Agent 1 is more risk averse than Agent 2Agent 2 is more risk tolerant than Agent 1
Modeling Risk and Expected Utility in Insurance Problems
2211 ** ,2 If
*)(
xUxprxUxprUEn
xxprUtilityEn
nn
UECEU
CExERP
Expected Utility:
Certainty Equivalent:
Risk Premium:
Dealing With Risk: Diversification (Portfolio Theory)
irE
iw
rE
rEwrEwrE
i
i
investment ofreturn Expected
portfolio in the investment ofWeight
2 and 1 sinvestment of comprised portfolio a ofreturn Expected
where,2,1
22112,1
2 and 1 sinvestment of Covariance
investment of Variance
porfolio in the investment of Weight
portfolio theof Variance
where,2
2,1
2
22,1
2,12122
22
21
21
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i
iwwwww
i
i
Expected Return of a Portfolio (2 investments):
Expected Variance of a Portfolio (2 investments):
Dealing With Risk: Diversification (Portfolio Theory)
yyxxyx rEwrEwrE ,
yxyxyyxxyx rrwwww ,cov222222,
Portfolio Example
Weight: 0.5 0.5 State Pr(•) x y x,y
1 0.200 11.00% -3.00% 4.00% 2 0.200 9.00% 15.00% 12.00% 3 0.200 25.00% 2.00% 13.50% 4 0.200 7.00% 20.00% 13.50% 5 0.200 -2.00% 6.00% 2.00%
. E[i] 10.00% 8.00% 9.00% Var(i) 0.76% 0.71% (i) 8.72% 8.41% c.v. 0.87 1.05 Cov(x,y) -0.24% Var(x,y) 0.25% (x,y) 4.97% c.v. 0.55
yxyxyx rr ,,cov :where
Capital Asset Pricing Model
[ ]portfolio a ofreturn = Er
fr
xr
mr
m
fm rr
-
mx
Xm
fm
fx
rrrr
-
+=
[ ]security a ofreturn = Er
i
fr
mr
fm rr -
( )ififi rrrr -+=
1
Capital Market Line Security Market Line
( )( ) Beta,
m
mx
r
rr
var
,cov≡
Capital Asset Pricing Model
3-Year 5-Year 10-YearMutual Fund Name Symbol Beta Returns Beta Returns Beta ReturnsAmerican Century Heritage A ATHAX 1.44 20.50 1.17 19.26 0.96 8.42Fidelity Advisor Equity Growth T FAEGX 1.18 8.31 1.16 11.20 1.16 3.34Fidelity Magellan FMAGX 1.33 6.88 1.03 10.42 1.04 3.53Putnam International Growth & Income PNGAX 1.07 12.55 1.03 20.56 0.96 6.90Fidelity Diversified International FDIVX 1.08 14.57 1.02 22.18 0.96 10.85Templeton Growth A TEPLX 0.77 5.78 0.85 14.81 0.80 7.01Vanguard 500 Index VFINX 1.00 5.72 1.00 11.18 1.00 3.43Vanguard Total Stock Market Index VTSMX 1.04 6.19 1.04 12.27 1.01 3.89Vanguard PRIMECAP VPMCX 1.01 9.63 1.06 15.78 1.08 8.50Janis Growth & Income JAGIX 1.13 6.69 1.05 11.22 0.98 5.84Dreyfus Premier Balanced B PRBBX 0.98 4.05 0.90 6.59 0.87 1.43Dreyfus Founders Balanced A FRIDX 0.98 3.71 0.88 7.21
Capital Asset Pricing Model
Name Symbol Beta
Aetna AET 1.08
Anheuser Busch BUD 0.60
Bank of America BAC 0.32
Boeing BA 0.88
Cummins Inc. CMI 1.35
Deere & Co. DELL 1.23
Dell DELL 1.81
Eli Lilly Co. LLY 0.43
Family Dollar Stores FDO 0.82
General Electric GE 0.70
General Motors GM 1.27
Google GOOG 2.01
Intel INTC 1.72
J.P. Morgan Chase JPM 0.68
Microsoft MSFT 1.61
Nordstrom Inc. JWN 1.51
Pfizer PF 0.75
Wal-Mart Stores WMT -0.18
Wellpoint Inc. WLP 0.61
Wells Fargo WFC 0.32
( )( ) Beta,
m
mx
r
rr
var
,cov≡
Efficient Markets and Economic Profits –Total Market Returns, Selected Time Periods
Economic Analysis of Market Opportunities
Monthly: Annual:Value-Weighted Equal-Weighted Value-Weighted Equal-Weighted
Index Index Index Index1/80 to 12/02:AVG 0.0108 0.0202 0.1370 0.2708STDEV 0.0464 0.0548 0.7234 0.8974
1/97 to 12/99:AVG 0.0208 0.0250 0.2805 0.3450STDEV 0.0501 0.0579 0.7981 0.9643
1/00 to 12/02:AVG -0.0115 0.0109 -0.1298 0.1385STDEV 0.0564 0.0778 0.9319 1.4576
1/97 to 12/01:AVG 0.0046 0.0179 0.0572 0.2378STDEV 0.0554 0.0685 0.9103 1.2135
1980s:AVG 0.0139 0.0152 0.1798 0.1986STDEV 0.0482 0.0530 0.7591 0.8585
1990s:AVG 0.0143 0.0279 0.1859 0.3916STDEV 0.0393 0.0474 0.5883 0.7428
Loss Aversion
You are offered the following bet: A coin will be tossed. If it is heads you win x; if it is tails, you lose y.
+ (Gain)+ (Loss)
+ v
- v
+ $30
- $10
Value = V($)
“Most respondents in a sample of undergraduates refused to stake $10 on the toss of a coin if they stood to win less than $30.”