Question

Part 1: Definitions For each pair of terms / concepts, define each term / concept and explain the relationship between them. The ideal answer is three sentences. One for each definition and one for the relationship. 1. Interest Rate and Future Value 2. Expenditure Function and Hicksian Demands 3. Marginal Rate of Substitution and Indifference Curves 4. Contingent Consumption and Intertemporal Consumption Monetary Value Hypothesis and Expected Utility Hypothesis

Answer 1

1. Interest rate is the price of capital or return on capital as a factor of production. Future value is the value of an asset on a particular date in the future. When interest rate increases future value increases.

2. Expenditure function is the minimum amount of money required to achieve a particular level of utility at a given price. Hicksian demand finds the cheapest or least cost bundle that provides a given level of utility. Solving for an expenditure function gives us the Hicksian demand.

3. Marginal rate of substitution is the rate at which a consumer is ready to give up a commodity in exchange for another commodity , while maintaining the same level of utility. Indifference curve is the curve that depicts the combinations of two commodities that yield the same level of satisfaction to the consumer. The slope of an indifference curve is the marginal rate of substitution.

4. Consumption or wealth based on the possible outcome of a random event can be described as contingent consumption. Intertemporal consumption refers to the choice made between consumption and saving made by the consumer over a period of time. Intertemporal consumption decisions are made on the basis of contingent consumption.

5. Expected Monetary Value hypothesis aims at quantifying risks or uncertainties in an event and takes into account the probability of occurance. Expected Utility Hypothesis shows the utility expected from the occurrence of a random event. Expected monetary value hypothesis says to choose the outcome having highest expected monetary value whereas expected utility hypothesis says that it is the subjective allocation of utilities to different outcomes of an event helps in making choices.