Transcript Interest Rate Experiment

First Exam
Econ 311
Money and Banking
Back of Room (JH 1125 7PM)
Seat
Row
1
2
3
4
5
6
7
Horiuchi, Barry
Chambers,
K
Ng, Ronald K Azoulay, Toni Pollard, Rita A Wilfred, Karl T Aijalon J
Ingber, Evan
Pacleb,
Michael O
Payan,
Ezequiel
Grotan,
Kabakoff, Alan Michael
Arakawa,
Takuya
Bounaga,
Zayed
Lord,
Stephanie J
Garcia,
Magalit, Ivan E Kenneth O
Nakagawa,
Marika
Overvold,
William L
Goetz, Jason Hamilton,
Hoang, Anh K R
Devon R
Manshoory,
Lohr, Jacob A Shaheen F
Sunairatanapo
Cortes, Rafael
rn, NatthapongLee, Daniel N Lee, Justin S M
Cristescu,
Tovar, Karina Michael A
Czarnota,
Philip J
WolcottShulman, Ian Al-Rashoud,
G
Mishal S
Montano
Chavarria,
Milagro E
Front of Room
Oseguera,
Manuel
Robinson, Ron Malhotra,
L
Aarushi
Cross,
Jasmine N
Whiting,
Claudia J
Shimizu,
Tomoyuki
Consider how expectations about the future can affect current behavior.
Use the graph on the next page and draw a person’s inter-temporal budget constraint if he
earns $100,000 today and expects to earn $100,000 in the future. Draw indifference curves if
the person prefers to even out his consumption so that he consumes the same amount today
and in the future.
Suppose the person receives a layoff notice and expects to lose his job in the future. Modify
your inter-temporal budget constraint and use indifference curves to show how this will affect
current and future consumption and savings and borrowing if the interest rate is 10% and when
he gets laid off he will receive unemployment benefits equal to 25% of his pay.
Suppose the person doesn’t receive a layoff notice but the economy in general enters a
recession and he realizes that there is a reasonable chance he will get laid off in the future.
Depict the inter-temporal budget constraint for this situation and compare and contrast the
effect on current consumption with your answer to (2).
Suppose the government passes a “jobs” bill which will increase or extend unemployment
benefits. Depict the effect of such a “jobs” bill on your graph. Will this type of jobs bill increase
or decrease the unemployment rate? Explain.
Even Consumption
$100K
Reasonable Chance
Expects to get laid off
$25K
$100K
Consumption today
An increase in the money supply will cause an increase in expected inflation (Fisher Effect).
If expected inflation increases, the expected return on bonds relative to real assets falls for any given bond price and interest rate. As
the result the demand for bonds falls (B1 to B2).
The rise in expected inflation also shifts the supply curve. At any given bond price and interest rate, the real cost of borrowing has
declined causing the quantity of bonds supplied to increase and the supply curve shifts to the right (B1 to B2).
The price of bonds will fall from P1 to P2 causing nominal interest rates to rise.
An increase in the money supply will shift the supply of money to the right. Everything else being equal, interest rates will fall.
Income Effect: the increase in the money supply increases output and wealth leading to an increase in demand for money.
Price-Level Effect: the increase in the money supply will cause the price level to increase leading to an increase in the demand for
money.
Expected Inflation Effect: the increase in the money supply causes people to expect higher inflation and an increase in the demand for
money.
Price of Bonds
Interest Rate
MS1
MS2
BS1
BS2
P1
MD2
P2
BD1
MD1
BD2
Quantity of Bond
Quantity of Money
Question 3
 Consider the Asymmetric
information explored in the inclass experiment.
 What is an asymmetric
information problem? Give an
example.
 Can the free market solve the
asymmetric information
problem or is government
regulation and interference
necessary?
 How might this apply to the
efficient operation of financial
markets? Explain and discuss.
 An asymmetric information
problem arises when one party to
a transaction has better
information about the quality of a
good being exchanged than the
other party.
 The free market can solve the
asymmetric information problem
by providing a mechanism for
assuring the quality of a good.
 Branding.
 Warranty.
 Return Policy
 This applies to financial markets
because when lending money one
party has better information about
the likelihood of default than
another party.
Question 4
 Consider the following article
about oil prices.
 What is the article saying
about the relationship between
the optimal forecast and the
expected return on buying and
holding oil?
 Suppose you invested in such
a way that you would make
money if the price of oil fell
below $75 a barrel. Is this a
wise investment given the
information in the article?
 Discuss in light of the Theory
of Rational Expectations and
the Efficient Market
Hypothesis.
 The theory of rational expectations
posits that market prices incorporate
the best information and forecast
about the future.
X e  X of
X e  expectation of the variable that is being forecast
X of = optimal forecast using all available information
 So if the market price is $81.25. there
can be no expected profit from
speculating the price of oil will rise or
fall.
The Curve
Grade
A
B
C
D
Score
65
53
37
33
F
0
σ
1.50
0.75
(0.25)
(0.50)
Count
7
11
9
2
%
20%
31%
26%
6%
6
17%
Summary Stats
Mean
σ
Count
First
Exam
41
16
35
First Exam with
Quizzes
52
18
35
Quiz 1
5.0
2.0
31
Quiz 2
7.0
1.0
28
Administrative Details.
 There will be a mandatory one week cooling off period
for any and all questions about the exam. After one
week, if you want to discuss your exam you must come
by office hours.