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The document discusses how equilibrium interest rates are determined in a simple model. It describes an investor who receives $10,000 income in years 1 and 2 and must decide how much to consume and save in a 5% savings account. Aggregating across all investors determines the demand and supply curves for borrowing and lending. The equilibrium interest rate is where these curves intersect, at the point where the total amount investors want to borrow equals the total amount they want to lend.
The document discusses how equilibrium interest rates are determined in a simple model. It describes an investor who receives $10,000 income in years 1 and 2 and must decide how much to consume and save in a 5% savings account. Aggregating across all investors determines the demand and supply curves for borrowing and lending. The equilibrium interest rate is where these curves intersect, at the point where the total amount investors want to borrow equals the total amount they want to lend.
The document discusses how equilibrium interest rates are determined in a simple model. It describes an investor who receives $10,000 income in years 1 and 2 and must decide how much to consume and save in a 5% savings account. Aggregating across all investors determines the demand and supply curves for borrowing and lending. The equilibrium interest rate is where these curves intersect, at the point where the total amount investors want to borrow equals the total amount they want to lend.
Individual Choice Problem Solution Equilibrium Interest Rates
Lecture 1.6: Market Equilibrium
Investment Analysis Fall 2012 Anisha Ghosh Tepper School of Business Carnegie Mellon University November 1, 2012 Individual Choice Problem Solution Equilibrium Interest Rates A Simple Choice Problem An investor will receive an income of $10, 000 at the end of years 1 and 2 with certainty. The only investment available is a savings account with interest rate r=5%. The investor can also borrow money at a 5% rate. Question How much should the investor save and how much should he consume each year? Individual Choice Problem Solution Equilibrium Interest Rates A Simple Choice Problem An investor will receive an income of $10, 000 at the end of years 1 and 2 with certainty. The only investment available is a savings account with interest rate r=5%. The investor can also borrow money at a 5% rate. Question How much should the investor save and how much should he consume each year? Individual Choice Problem Solution Equilibrium Interest Rates A Simple Choice Problem An investor will receive an income of $10, 000 at the end of years 1 and 2 with certainty. The only investment available is a savings account with interest rate r=5%. The investor can also borrow money at a 5% rate. Question How much should the investor save and how much should he consume each year? Individual Choice Problem Solution Equilibrium Interest Rates The Solution The optimum consumption pattern for the investor is determined by the point at which an indifference curve is tangent to the opportunity set. Individual Choice Problem Solution Equilibrium Interest Rates Determining Equilibrium Interest Rates In the above example, the investor wishes to consume $8, 000 in period 1 and lend the remainder of his income, namely $2, 000, at r=5%. Summing across all investors who wish to lend when r=5% gives one point on the supply curve. Similarly, summing across all investors who wish to borrow when r=5% gives one point on the demand curve. By varying the interest rate, the supply and demand curves can be traced out. The equilibrium interest rate is rate at which the demand and supply curves intersect the rate at which the amount investors wish to borrow is equal to the amount investors wish to lend. In this simple world, equilibrium interest rates are determined by investors tastes and income. Individual Choice Problem Solution Equilibrium Interest Rates Determining Equilibrium Interest Rates In the above example, the investor wishes to consume $8, 000 in period 1 and lend the remainder of his income, namely $2, 000, at r=5%. Summing across all investors who wish to lend when r=5% gives one point on the supply curve. Similarly, summing across all investors who wish to borrow when r=5% gives one point on the demand curve. By varying the interest rate, the supply and demand curves can be traced out. The equilibrium interest rate is rate at which the demand and supply curves intersect the rate at which the amount investors wish to borrow is equal to the amount investors wish to lend. In this simple world, equilibrium interest rates are determined by investors tastes and income. Individual Choice Problem Solution Equilibrium Interest Rates Determining Equilibrium Interest Rates In the above example, the investor wishes to consume $8, 000 in period 1 and lend the remainder of his income, namely $2, 000, at r=5%. Summing across all investors who wish to lend when r=5% gives one point on the supply curve. Similarly, summing across all investors who wish to borrow when r=5% gives one point on the demand curve. By varying the interest rate, the supply and demand curves can be traced out. The equilibrium interest rate is rate at which the demand and supply curves intersect the rate at which the amount investors wish to borrow is equal to the amount investors wish to lend. In this simple world, equilibrium interest rates are determined by investors tastes and income. Individual Choice Problem Solution Equilibrium Interest Rates Determining Equilibrium Interest Rates In the above example, the investor wishes to consume $8, 000 in period 1 and lend the remainder of his income, namely $2, 000, at r=5%. Summing across all investors who wish to lend when r=5% gives one point on the supply curve. Similarly, summing across all investors who wish to borrow when r=5% gives one point on the demand curve. By varying the interest rate, the supply and demand curves can be traced out. The equilibrium interest rate is rate at which the demand and supply curves intersect the rate at which the amount investors wish to borrow is equal to the amount investors wish to lend. In this simple world, equilibrium interest rates are determined by investors tastes and income. Individual Choice Problem Solution Equilibrium Interest Rates Determining Equilibrium Interest Rates In the above example, the investor wishes to consume $8, 000 in period 1 and lend the remainder of his income, namely $2, 000, at r=5%. Summing across all investors who wish to lend when r=5% gives one point on the supply curve. Similarly, summing across all investors who wish to borrow when r=5% gives one point on the demand curve. By varying the interest rate, the supply and demand curves can be traced out. The equilibrium interest rate is rate at which the demand and supply curves intersect the rate at which the amount investors wish to borrow is equal to the amount investors wish to lend. In this simple world, equilibrium interest rates are determined by investors tastes and income. Individual Choice Problem Solution Equilibrium Interest Rates Determining Equilibrium Interest Rates In the above example, the investor wishes to consume $8, 000 in period 1 and lend the remainder of his income, namely $2, 000, at r=5%. Summing across all investors who wish to lend when r=5% gives one point on the supply curve. Similarly, summing across all investors who wish to borrow when r=5% gives one point on the demand curve. By varying the interest rate, the supply and demand curves can be traced out. The equilibrium interest rate is rate at which the demand and supply curves intersect the rate at which the amount investors wish to borrow is equal to the amount investors wish to lend. In this simple world, equilibrium interest rates are determined by investors tastes and income.