ECN 203 1st Edition Lecture 4 Outline of Last Lecture II Relaxing our No Scarcity Assumption III Relaxing our No Production Necessary Assumption a Value from marginal product IV Relaxing our No Future Assumption a Intertemporal b Discount and Discount Rates c Present Value V IntroductiontoMutations Outline of Current Lecture VI Quick Review a Discount Rate Present Value VII Relaxing our Risk and Uncertainty Assumption a Risk b Uncertainties c On Role Models Current Lecture Quick Review o Discount to diminish the value o Discount Rate price we pay for waiting o People who want more cash rather than cash at this very moment have a higher discount rate They do not place a lot of value on the future This comes from your preferences Discount Rate vs Interest Rate Higher the discount higher the interest rate Ceteris Paribus If they aren t willing to wait you have to pay more interest so they will want to wait These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute o Present value Determining intertemporal choices Takes future utilities and calculates if it s worth it Decision rule Discount rate is used to determine what your future means to you now PV1 PV2 PVn Relaxing Our Risk and Uncertainty Assumption o o Risks Things that might affect our plans for better or worse and about which we have some sense of probability as to whether they will happen Different choices have different perceived risks associated with them Among choices you do not assess the present value you factor in probability Risk perceptions change throughout the life cycle Uncertainties o Things that might affect our plans for better or worse but we have not imagined so we do not assign probability Building Risk into the Decision Rule Expanding the decision rule to include risk expands our scope of our decision rule beyond the present value PV to the expected present value EPV o The E reflects how much one expects to enjoy this utility give this perception of risk the higher the perceived risk the lower that expectation EPV1 EPV2 EPVn The V value captures our individual productivity and preferences at the margin The P present reflects the fact that the future stream of utility that the choice generates is discounted back into the present based on our individual discount rate The E expected represents our adjustment for our perception of the risk associated with that choice You can change a person s behavior by manipulating a risk o On Role Models Preferences If you never see a person of your gender or your race in the role of for example a lawyer then it is hard to imagine yourself in that role It won t be in your preference ordering Discount rate Many career paths require an investment in your education which means waiting If your role models prefer immediate gratification then it is more likely you will turn Meaning you have a high discount rate Even if you can imagine being a lawyer an absent role model sends a signal that the probability that you will make it is low Low probability high risk High risk ceteris paribus a reduced likelihood you ll make that choice Risk
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