FNCE 3P96 Lecture Notes - Lecture 2: Capital Market, Indifference Curve, Interest
12 Sep 2015
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Consumption and investment without capital markets: assumptions, certainty, no transaction costs, no taxes, decisions made in one-period context, initial endowment, positive marginal utility of consumption, one person and one period one good economy. U(c0: marginal utility function is positive (every individual is assumed to prefer more consumption to less, but is decreasing with consumption; it has a concave shape. U(c0,c1)); these combinations (illustrated graphically by a contour) are called indifference curves: all combinations of consumption today and consumption tomorrow that lie on the same indifference curve have the same total utility. Without the existence of capital markets, individuals with the same endowment and the same investment opportunity set may choose completely different investments because they have different preferences (indifference curves): everyone will have our different equilibrium. 2: with an initial endowment of (y0,y1) that has a utility equal to u1, we can reach any point along the market line by borrowing and lending.
