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  • CoreMacro 1

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    latarn
    238 views116 pages
    1) This document describes a recursive problem modeling dynamic programming to predict consumption over time periods T, T+1, etc. 2) It establishes equations relating consumption in the current period (T) to consumption in the previous period (T-1) and a multiplier, with no initial consumption. 3) The equations are solved recursively, backing into the periods to determine consumption levels at each point in time.

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    Original Title

    CoreMacro_1

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    1) This document describes a recursive problem modeling dynamic programming to predict consumption over time periods T, T+1, etc. 2) It establishes equations relating consumption in the current period (T) to consumption in the previous period (T-1) and a multiplier, with no initial consumption. 3) The equations are solved recursively, backing into the periods to determine consumption levels at each point in time.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as pdf or txt
    238 views116 pages

    CoreMacro 1

    Uploaded by

    latarn
    1) This document describes a recursive problem modeling dynamic programming to predict consumption over time periods T, T+1, etc. 2) It establishes equations relating consumption in the current period (T) to consumption in the previous period (T-1) and a multiplier, with no initial consumption. 3) The equations are solved recursively, backing into the periods to determine consumption levels at each point in time.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as pdf or txt
    of 116

    GH.1 Dyoo.

    Mic PI1l~mCV\MiVla
    ® RecLArsi ve ?ro b\eM

    , . ...
    VvV1eV't ),to\:; ':::: en>''\) vee-toY" of gtan, vllri~1?le. at t-:::. 0)1) ... , T+1
    ..,
    lA -= Ckl(1) ve.c..+OY" of Con-h1>\,V~rla~ tAt t ~ 0, 1'''~:1T
    il

    ole&iSIO() VCt'YietW

    c,J.tIev(l, A-t -:=- (hlC,\) veCAot of l00mY1¥ M(;(ltiplievg f'oy t:-O;1) ..,... T

    FOC: ~
    C;lLA-t
    - 'dYt"(;){t", Ut)
    ~ltt
    + eY9 t l){1;. lAl,) .A-\;
    alA..
    := 0 (1) vt~ 0, .", i

    'Oi.
    C>~
    dY"t(.).(t,UtJ
    o)(t"
    + d(::ll; ().tt"lUt)
    a).(t
    A1; - "'\-\;-1 -0 ('2.) oqt"" 1,.", i

    (~)
    'd;f. := W; (:}(."1'-tI) - AT' - 0
    01)(1'+1

    'd'i.
    'CI)..~
    - gt()(t,Uoj;) - ).t1;+-1 - 0 CtJ-)

    itS€, ('2.') ; )...1:.-1 ::: dY.. ()(t,Ut) -\- 014hL'}(.j;,Ut) ~

    ~)y, ~>tt ~

    - --- ------------- ~.

    (j~ ~
    dYt +I
    -+~I AVI

    \..-
    C»)(t+I
    C))A'tH

    :::.
    ;\."_1 ~!i:.. ~ ~f AT
    O><r- ~).t.1"
    2

    .• ~. .. f."· ~. :

    ~ \ () CQ. he-', S f}11c}.' ~ po h'-t(.j M:.. f lA. t

    y(~
    = hJ,>,(t1

    ~*t

    To S-hAd.4 D'f()~MIC Prot(1t""'VVli~ b'f U~i(l9 1bac,K.liVorz:L (ewfb;vel~,


    VI e, be~i{\ V}t t:: 'T (b,i pe rlO~ lis ~ It! ~ t pen'0 ci we,. co VI Ij \Ie.)

    a\A.c;l. 'IW~) ~DLv[lI.~ bo.ckVJ~ vtV'l.fli t -- 0


    At +tiV\t T-t~, tltle(€" vVl1l 'oe, no CongUMptlcm =>1 YlO VIr..., ::=) ),(T+I = 0 C>CT~I.'h) -::: ()

    At \i(V't.. \, PO\lc(,~ R1; lAT -::: lth(~) - IVVlpllcH FYI,


    3

    .~~ /~~

    Foy t : T \:Y~
    1-1---+-l......,.....---1-1------1-1- --1
    o 1 2 T T+l
    clie,

    IV) -thiS ~} ne IS t;nol~ \ (AT vt -;: T - k equaHMS


    ).(,. .... , VI eq U:h' 0Vl S
    (V\{A')( Y",. ()i.,-. \A,.) + Wo (){n,)
    \AT

    S,t. ~+,o:::. g,.L}(,-"lAT ) \-+€, Vw5 -+z> soLve. (Y1-t-K..) e.q,ua~·ons

    ),t,- \$ 9'IV e-I'l , . - 1Vl1'S \~ a S<A 10 p<obielVl Ot p-obluVi ~rOYe-.

    £., :::- '!T(~~lA,,) +W,,().e,--t-I) + A',-fq,..c),(,-)l.A.,.) - ),(T+~


    1='0(,: ~:t "= ~ 1" ()qr >-'1' -== 0 (b)

    dIJ,. glA.,.· ~lA.i-

    (:t-)
    2Jt.,
    (;l)t...
    =­ Q:i'l,.
    a~,-
    ..... ~T
    ~),(1'
    )..... - AT-I - 0

    d'i w~ ('),.(~T+·\) - .AT 0


    (0
    ~){T+'

    'd'<f.. q,- ()CT, u.,..) - ~-t-I 0 CCI)


    f}A,

    fuM (17), ~O:

    'dY"r
    C)l.t.,.
    +~
    dl.t.,.·
    w: 04+ 1") o (10)
    l'
    o.l·(,lbse;to~ c;)

    . PoHtlf fy\.; IA,.:: Irl'f(),(")


    UH\ = 9T[').fT. nr()(T)]

    ~Y'",L)(,-.h,.()(,.)1 +' ~gr[}C.T) Y\,.c),(T)l W:{qT[).<'T)h'-().(T)]~ -=


    al.tT C)\,l,.

    --------
    4
    Q't 4­ ott
    -;) 2.k
    ='> 2 h..
    ~ Z (n+k) equaflcm~
    T-1 I
    I
    o Z.

    S, t \iT" _. gT-. ( )(T-1, t.lr-.)


    ~+I ~ gT"C~T' (AT)

    )RT_' is 9iv€V1
    \

    ;t :=: 'IT-, ['),('''_'' LA r _1 ) + Y-TC~T' Vl T ) -t WO()..(-r+I)

    + .AT - 1 [ gT-. (){r-17 tAr _.) - ).(,.l + AT [0T()£T,LA.t) - 'l-e1'.;j

    poc: d;t = df'T_1


    + 09 T-\ AT_I 0 (11)
    .~lh-I ~ OUT-I

    d<t.- - ::::: a (12)


    d~T-1
    Cl)(r_1
    + d9 I _, .AT-I
    ~Xr-I 21).{,-. I

    ();i - ~ gr .AT
    + dd)(T ~ AT-I 0 (1'3)
    e>).(T 0>),( T

    d;;l
    d){T+1
    =: w: ()JlT~') - Ar 0 . (14-)

    FYOI'Vl (11) , (1 gj : dl'i-_I +~


    ~ Vll-I dUT.'
    t~ ~ ~ [w;()(~,)l \
    d~T ~)(T
    0 CIS)

    ,\1, Notehl ~"-l i~ {)t. 5\Ztte V. it1at doeSVl/t c1e*efMill.tei '*u 1l((JII()ML( cd P(},ljClI't
    ..... -r - 1

    ).eT" = 9"-1 [)(r-I, VlT_1(X T_,)]

    ),tT'" -::: 9T [t-€T, hT(~T)J


    ~ solve- $\!'I~\1r.4VIeclAsl'i
    ~ c~ UlJV'l cte-tefMifle. Cifl => ~Hz. =) Ct-t~ ,.,) .. ,

    ~ C{; c.al1Vlot cktet'lvflr'le, ct - 1


    ef. At- 'Ii/Yl"L t 7 ).(t IS Sht+e, V.
    ~ \<Mown f.'nJ -this CU foliC<.( -ii-t .
    .~ ,j
    'J.e HI '= qt().(-t, Cot)

    ::j

    ~V11 '1 0 v.. will KIIlOW ).(t-fl

    A+ H(\I\e, t+'\) J-('HI k;luo(VIt.s gmte.. V :::.> Ct + 1 ~ )..lH2

    At t1rvu. t+2, 'Kt+2. k7ecoNl e5 gmte. V -::;) Ct-t2. =) ).(-t-t1

    P.>'1 i+emtion, fhellM'tt1'S EqLUttlOfl can be. d-evlvec(


    since 'Iou.. eMl 'h'nd. oph'MtxL poliCI'e.s by t)Sf(19 btU:.k.,wfXrc( Met£-tOa.

    ~ A-\;::: snad.ow vo..lVl,e ot' resource.s at tiM,(.. t.


    (oppoyt\.(V\i~ eDst .of not \-(sl(~ (0S0UY"US todo.I.f) U6\I1\;YI'U6"\O"YYI) l~eJrn·l.le)·u)A!l" 'iu. lIeJJQ~fL1.l
    ~~
    et ,<;o..vhlj. thY' &+u<e" \nve~ttV\e"'t,

    8ellIllClf\'S OptiMCllit'{ Principle.


    --') A'{\ OptilVla-t poUC<f WS tltle.. pV(;lperfy +VlC\:t", . vJ.;JetltJev tlrte.. "lVllhd &trlte. &. decisiCJVl aY'e..)

    -lYle feMt\.iV'il'1g deciSions Mvst COl1stitute... an OptilVloJ. poUCl.( ~ ye~a-rd -+0 H1e <;tclte.
    (es\.tltin~ -FroM the first c\uisioV'l.
    b

    ®' fOeUMQ.t1'S eq,uttti OY'\


    000~
    AI One- Perio~ PfOblczlVl I \--4
    o i 2 T-1 T 1+\
    L.y-.J
    \III~l£"') :: t-PtMOO Valtu- t:'vI
    1- p.vlOclle*t 1l' solve,
    S:t;, }(TTI = 9 f( ~,., l.l,.)

    ).{,.. i s ~ iVeVl

    Foe: (1b)

    ~"'+I

    A-,­
    r;YWe\op COYlclil1OV1 :
    I
    WI ()(,..)

    weA.(!ntefunc-nor'\
    o~ the, eCOf\OM'j

    RoM Lib)' ( n ) _ - - - - - - - - - - - _
    Mo.r~l(\aL Cot'\c.ii-nor'\
    toy \AT

    -= 0
    a:i(~~ ~~ 'rflc!\reC+ ex- e<:k
    \ I

    w~ (><,.) = dY',...[).{,..,n,().(T)1 +
    ~><T
    . r: •.. ~:' .'
    y ~.."
    I , 1----1
    o 2 T-' T 1"+\

    ~
    W~ (M,--,) -:= 12- Peviool val~ f"Vl

    Ma.x
    lk-<
    ['(,.-1 (),("-I, LAT.') +
    s.t. ..e,..-== (j
    :11".1
    ( ){,..-I", LA T- I)
    sUo I'D(·\"·I)
    --> IS rul9-P'?'~ of l---~·-----,
    Wr..., (),olo) ... (lAo-x l';, 0(",«,) 1" W'r (l.<',) :

    <'i.t. )..('1 '" q,,(.I'I'o,uo)


    ).(0 qiYe.-Vl/
    -----------
    (2.\)

    ).{,. :

    Sl'welop Cono,",tiOfl:
    I·
    W2. ()otT.;)

    w~ ()(,.-I) :::. dV-r _l . + ~ [w,' (){.,..)l


    a}(,.-I 0>4-1

    nvM (2.0'):
    I
    o

    PolrCl{ Fn: V'T-I = [,.",.-1 ().(T-,J

    r.-o (V\ ('2.~) : ).e,,. -::. q1'~ L


    ).{,. " [,.,,.-1 ().l,--I) 1
    :.. .. - '"'; :'" ....... !I',

    fOt: IA.r-j Clfr_j + d9T-j AT_j ::: 0 (25')


    OJuT_j dUT_j

    'l-e T-j +1 ; wJ (~-jol-I) ~


    AT-j (2b)

    AT_j .- ~T-j+1 -= ~T-j ().{T-j, LAT_j) (2~)

    EV'V0\ope Cond-i-non ~
    I
    WJ+I C'l-eT_j ) ':

    (26)

    PolitI.{ Ft.1: I:.AT_j = hT-J (){T-j)


    1/
    'V

    I ),(T-jol-I = 0r-j [).£T-j, VJT-j ().(T-j)l


    J
    q

    m€- <,otw.. 15 tv ?rocee.-ct Yec(,(r~lve~ & tv wov[..c.. backwor-r,l

    1) golvl~ tVie.. 1- penotJ.. probleM vv"'t'lt1 j +1 -::: 1 =) cted-u(,/~ Wt(xT )

    2) Solvllt9 the.. '2.-peYl'ocl pml?\e(V\ vy j+1 ::= 2.:.) '" WZC).{T_,)


    U
    'J

    iVl€, ?l1>ce!vis Yepw.:ted. (Anti I lrJe obmlVl Wi +1 (),{())

    . o"V\.cl. alSo ctevive itle.. "FMo1 t'eeclbaGk. n"de lAT-j === hT-j ().(T-j ) Vjo: 0, .. " T

    v) (:r+1)· PerioO P~blel\l\ :.~~: "


    . .
    /'"",
    '/ ,/
    .... .....
    '3r~~
    . t-I--II-----1If------lI_-4I-- --I
    o 1 . 2. T-I T i+1

    1
    'v-J"'HLU,,) = fIIo.x l~C)(o,\A,,) + Wt C'l-€1)1

    s.t.. ).e, =
    lilo

    9oC).(o,uo)
    ..
    ).eo ; S ~'lveV"'l

    1'Vu.. solu.lioYl is -tfN.. S~~ ,,~ (5)=

    OptltYltU PoHci~ : vt'!; = v,t()(t)

    ~t+l -= 4lt [)(t; VI,,()·(.t)]

    ~ S'o\ve tW. f't'0Io\~(111 b'1 uSing bl1c~wo~ fV1e*lDd, Cl3eUMan/S 6qy.£{h'rJYI)


    ~

    '.' .:: 'Thf,Vl,: .. -tW, OptiMal po\ici e.s (A{e so.io. to be TiMe Cort~iS~l'\+ POUClU
    ....... ·· .. C4l0~t CO-YI't c[tu{f\~ / do better +VtttV1ti1ese op+7M~ pol/cies as f}ll1e ~Sf by )
    ~,,\ve *'-t innenvtos+ b~c..k t f!'rst lAVltil (ea£'~I; t-=o =) citvlVe. "OptlMcJ. pol ,'Ct'tS " e~ FI"''cd.

    ~-b11 (}to) '= Maxfyo().(o,u,,) + VlMIY'I(),("lA,) + ••• + tv'\(;l)«Y'T().(1',lA.T) + WO().(T-+./>1 2


    ~ ( ~, . ~T I
    ~n. ).(1 ==- 9"()(,,,1.l,,)

    .)(0 is give...
    10

    @ 11lV1t CmtsistenO{
    Tf you ove, at t'"' 0

    0'( If V0v.. ().{e, a.t t:: '3

    'i t ':= 0"", T

    I .
    '\fie Opt\McJ. policies V1o.ve 0.. ~e.lf-enfoV'cin9 property.
    1hus, as t1Me- peus bt..(, t\t1~"(e IS no 11\e.tnBve (-fbI" The ~ovt) 10 Clt\af)~ trOM ~

    opH MeJ., pol; ues ~


    ~eUMt\(\l.s P~Vlc'fle 0'; opnMal.lh( .:' ;' ,I' ,.,'

    \,1 ~& clef p. 5


    'V

    A) PoHClf Fn doe~ not v().(\{ OlJev tiM e


    ,\) LA Slf1g 'SellMQtl'S Sq,l,tanon o~ [j+1) - PeviocL PtVblef\l1

    2) Let tYle poll'ev tuVlc:h'on Vtj eonve~ as j ~ -oe

    3) Assl1Nle) 1
    V'\().(t,'Ut) -= ~1; '((~)u~) 1

    ~ellMal')'S Eqv.Ctno(l becoMes:

    IfJj-\o, ().{'r-j) = M(Ax. [~T-j ('(}(T~) LA,._) + Wj(>-e,._j+l)]

    ~T';

    PJeUM().n's Ettu.oJior1
    ~ t~vfet1t Vtt\~ Ft'\

    ....
    valw.. .fv-.'
    at t:=-T-j')
    ~ 'vj...., (~'-J )

    ~
    fuiYeVltVo.!;,u,
    at t:=- r-j
    -U (~diSCOlkl1 r vaku)
    .
    11

    j := T-1 ~
    .
    . ~:-
    ... ,.

    V(r.,)+\ C'~~NT_I») := Mo.",


    LAT-(T-I)
    Lr('llT.CT-I), (AT-CT-t))
    -' -.
    -+ ~ Vfr- o( ){T-CT-I1+- llJ .
    ~. ,~ .> ••

    V,(Yl..1 ) = Mo..~ lr(>-f"lA,) + ~v"-l().t'a.)l


    lA 1

    :::

    ./ ,,-
    , .... ;'
    ...... .....
    1----1
    o 1. '2 T-1 T '1+1
    ,."----------...,...---~./
    ~Dlve. fz>v T 9e.10c!s

    'If

    Vj +I C),tT~j ) == MO:)(
    "'T-j
    [r ().("T-j, lAT-jl -l- ~ Vj b(T-jt-,) J
    ~,t_ ).(',_j+1 -= ~ ( )(,-.j 7 U"_j )

    solve. -this pl()~le(VJ ba.ckworol (ec(.lf(\ve-l~

    If V -::: \'IM'! - -w show 'If Co/I~urvtey lIves forevBv- ":=)

    j ~oC VleJ<t 0P.Aocl vali.u..


    \/ T'~
    "V of g\'Z{re, v_ .
    ..... Polk:" Fn v-111 (lot- vOrl-(
    over tiMe.
    S,t. ){ ~ gC)(,IA.) 1Oetlt\1tUl'S E~uatioYl
    ~ II; 91v€-V\ ( ColMpClct FoiM)
    hi' Infirtite.- fleriocl verl'ioY'\
    12

    Q,) Dlscou.nted. 0Y()G\MlC Pm~t'ltM1'\I\it19 P(lJl?\eM


    ~ l.iM V CaVl 1uvYlecl out tv be 1tu.- optiiVIoJ. Vall.(.e FVI 101' t\r1e..

    J""oO

    IVl'finH'y ~t'i2.Dntttl ~~letl1

    Uilefe, ('()(t,14) -= fettA(rl'.fvt of ~ c(e.ciSiQrl, ~ sm+e y.

    Y('l.to) has a uVlique gtyjcHL( COYlCQlle soLutiCWl

    4 g,'IMilav tv lite-tiMe utilit'-( fh

    y. -If (b~ 0 =') prefey euVYel'lt C()(1Sl.ltv?h~: .


    J
    (b""'" 1 -:::-) inoHffE'feYit 9-w w~t &.fu-hMe, tofIl.lJM?~CJ'I

    y - -- - - -~-----

    VlO SUl:Jwnpt t ..
    .l.!.t
    • '. Op'r\M~ policiQ-S \Nlli be. iht saMe m( tll,1 pe,iwS
    (op+l(IIJcJ, ?olfcy is- uV1iq.t,te g.. tiMe 'HwaviovYT)
    ~
    "-'
    ).t ::: 9[ve1', Y\(){t;)l
    II
    'V

    [VC") ::: Mo.x


    IA
    fD.f.l.t) + ~V[g[~h().(t~~
    I
    ::: . ay-C).(,u) 1- ~ y/()X) ~q'~t,h()4)l
    ~}.(. c»),(
    ... c ~.. " • • • ~ ~ .'
    13

    c) .Nt)(lstocnasHc .Ey,aMp\e~
    1) ~o.v'ng u(\c/.er" Certti1V\1'1
    Mcxy: i.t=o
    ~t ~(c-t)
    S, t, At-t-," = R t ( ~t + At - c/o)

    1'.0 giver)
    ..
    ,,*,€Ve . 0 L ~ L. 1

    Rot ( .) == qr1JSS (l:'t:re of r€rw () on VlOVl Itt 100 v wea 1t1rl 6l"t rime.. 1;

    ASSWVle., \; 'I.. = .,\ 1.&-1;-1

    i:~) Rt '=' l<. "> 0

    t<>,A> 0

    '\\~)
    s,-t; :::: Yt+ At. - Ct
    Ct == Yt, + At - St . '

    , eo~\ 'I.

    ~O
    ~ ~
    ' j .", I I. , ---~
    o 1 2- ,._~ 1"' i+\

    tt
    ql\/e,V\ \Jo.\ue-: At­

    Y""
    I<-t--I
    ~ -V:

    14­

    .' ~
    ..
    .'
    "
    ::

    . Poll'c.V m; 1St = h(y~,At1~_')(


    ~

    V~(Ahl:lu Rt -,) =- OilA. dl!!t+Ab- h(Y!j2A~?~\;...)1 -r ~V:[Rt·hcy",At2R.-~, Yt>\Jl<~ R.t ~'h(Yt,~,Rt.;)


    ~~ (M~ ClA t

    u.'(c~) [" - ClhCAt,'1t,12t_l)l + ~ v~j}2.t·lA(Yt,A"~,,.,), ~t+l' Rt1 iZt dh(l1t,At.,~t-,)


    ~At j aAt

    ::::. l).1(C t ) - e>h(At., Yt, ~t-l ) [tA'c.e.) - ftV:(At~" Yt~" Rt) RtJ (1)
    dAi; ~
    1\,.., .:=0 £OM (2)

    foe; St : dlA ,~'C~')


    Q)Ct .~
    + (!> v~ ~i4~i. Yt~I' Rio) Rt -= 0
    -1 LA'ce,,) =- f->V~(At-t1.,I.J",,~) ~ (2)

    , ,
    fiv(Vl (1),(2): V/I (At, II ~ J I<t.-I) -=
    \,l CCo/; )

    V~(AVI' Yt~l' 12,,) =- lA'CC-t+,)

    I I
    LA (C t ) -:=. (b' R\; I).'C'\;>I) 1 SAle)" ~itlAatiOV1

    e,:.. !.f lAce) -::: ..MA.C


    ~V1) _1_ ~ ~ «-10 _1_

    Cot; Ct+1

    CHI = f.> Rt; Ct­


    iii"

    2.) OpfiMttl Cm>wth V~d.eV' U('Icertu'ltJt"y


    Mo.'" it=o ~t [,t{e t )
    g,t, Ct + Kt"l := f(~)

    L-- 1<0 giveV\. ----l.\ .

    ~
    lA'Co) :::: +oC -;) LA'> 0
    U+ililf is gh-ictlL( conca.ve. t,.
    \,t" ~ 0

    -9 'Co) '; +oC .;.) f"> 0

    f".t:. 0
    1 Prod"

    ., tlxrWt.
    is dvictll.( toncave fYI,

    •
    t ,­
    At lLU-t ?~V;od.. T, . we- Ytllvt -ttu. yef\llCA.inlfl9 CClprt-aA V~T o.tv-ectaL{

    f1f' -rh( s pg.yi 0 et) 1itu- consu.(VIt~ \Nl11 eoYlS UlVIet' it all gin c..e. it "s tl-i.e. last petiooL iv
    ',Ve., I

    , , , I
    e·oiEJ I ---I
    o 1. '2 T-1 "T HI
    Valv.L hAne-tiDYl.
    (,iM'I\Ctv tv "YVlcf,{eL-t Utirl·~ f'" I')

    At t -:: T-~ i , we. v\IAVe, 'fltle. ~el'Vlo..·lVliV19 c.o.p\h;vt k T - 1 alV'~lf

    1It\.tY1, we use. k,_, -tv CtlloUlte. to\" 2 periods util·,ty


    ~

    Mo..')( u(c T_.) + f> l,l(c-t)

    q,t C'_I + V....,. ~ f(k T- ,)

    CT =- .f'(KT)

    L-----------,

    I~

    ;;t -= Mo.x. U(C T_,) t3lA(CT)';';-.A:;,,"",lCT-tI+kT-f(kT~I}:-'~TlC..~.-:f(kT)l


    CT-I~kl'

    f V,( k.) = MO-'"


    Co,k,
    l). (c~) + (3 VT_ 1 ( k 1 )
    I

    If T-"oO
    ---------'---­
    'fh.ev1, VCk) ':::: Mo.x lACe) + (bV(k!) 7
    c,~'

    I'"

    ,
    Foe: c: lAc - A
    k' : (bv'(k') - ).
    ~

    \).~ - ~ v'Ck')

    EV\\ie.lop CC/Y1o.ifioY/:
    vh.) =:: ;A f"o~.)
    " .

    r LA'(Ct) - (b lA' (c-t-t;) .p (k.t~,)


    I

    f'(~I) = l.,l'(Ct )

    I!> U,'(cu,)

    := LA' [ fCkt;) - kt~\l


    (b Lt'[f(kt+,) -, kt-n 1
    l'
    I-:t-

    g~nC-L iYJe- oph~ polrcy ~: I kt+~ = 'vt(k~",,)J


    ..;j

    1"I-'\I'S ~ MuSt be. V10Yl ciecYB-ewi~ ~ of -kt-t,

    hLkt,..,)

    C+)

    ~l)/~~:-tt) [lA~~~C ..)(~)1)J l,I.{~~)r~ V."~~t+I) [fr~t+,)- ~/(kt+l)l ~ ~o


    LR> IA'
    (+)
    r
    ( Ci;+')

    II
    f Ckt...,) > 0 ::0) CCYlt@.olicfioVl_

    1"',
    .'. rh'u<t-t,) ~ 0 j -tr> sotist!.t tk.t.
    : ~\V.-I1Or1('Y\j t:q,u\ 1;\ \,yi \.lfv'l qyeen. C/,lyve..
    "'L~) =: It,
    I
    h(,k;) = \<.'1. I
    E\.\\ey 6q,v@;\i0Y1 tells US tfAe sloee of VtCut-t-,)
    htk.) =0
    I
    I .u.. .- ..:"- '
    ~ \<.'3 k. K;;'-I

    ~'- . - 1VliSW'(\I't £C:A:hS'f'i~"Optlmd po1fCl1 ~


    Morloltl,,¢, bOIAY1c;(u1. i€~er'l'" - fupi'W noc-k iNlll felVlC\-i Y1 COl1stOV\t aftev k*
    ~
    ft\t.)
    K:l> k, % \'-\'ck t +,) ~ 0 , \
    f(\<..O) - - - - - - -Fek)
    f(\c.~) _
    f(;k) I
    (Jffl(..l y '=' fC,k) 1 I I
    +:-~-:.k-;-·------+k-~--. ~
    g. fck.) ~ 0 ='> ~ i OVey -hM.(.. ~
    after- k.-' , Come fI-o.,. op\iM&J. pcMtl.(
    .. t

    f'/II).)( Ec I ~ f().tt,LA-t)

    vo
    !;i,t. ~t+l =- ~ ( ~,~, £'t+l)

    ).{o is ~iveV1

    [.JIIev€.- So::: E"KpeCctecl vcdue

    1(,.'1;+1 = 0.. seq,uen(.,(. 0 f L,i.cl. Ycmd.(j(Y1 vav1o.loles 'vJ eU(\'1l,llc~Jive Pro0.Dis-t FVI

    I (IVlett.peVld€V1tlL( t 1c1LVI+-i~~lt{ CUSh7)uftecO

    ~ is (ecJiz,tcl at t+1 o..HeY" lA-t \t1as b1etVl deci~ oJ 11CY1(!. t,

    1f ),.(t-tl :F Et; O.lt+l)


    ~
    +his 1'$ ~c. of £h+1

    .WM':.e: EtV[q(~,LA, ~)11l-e} = Sv[~(uJLA,t)J d.F(S)


    ......... ~ ...., ,..",.
    ...

    VC'.t} .. ~. QpnMcJ. value of -ItJe prol?leiYl ~mY~ ~M ).!o

    FOc: LA: o

    v'ci..) .~ o
    '"'
    )(
    ,#

    Evwe10p CcmctHicV'\; v'c).{) - dY


    ~)( + ~Ef~J. ~~l}(~ .
    =0
    I
    V(){) =: ;j'( .1,/

    .Hot
    ~

    1) eo~SW\l\pnOYl wiiVl a. r<"t'llMM Retwr"Yl


    . ~.t, I

    MC\.x Eo L.. ~ LACC-t)

    t·o .

    cz,.t. AWl ~ ~(A~-Ct)

    ·,~t ::: At - Ct

    Ao 0iv'e Vl
    i,Mel'f.. r<t:: qrrm rctt(,. of ret"u'n OYJ. A-sretg ~ t J. t~ I

    A-SS\,lM..t, Rt is kvtDWYl ttt tlA.t b~;~JI1iYl9 of p~IOo( tTl) etHel" k..J,wwl"", c~)

    , \,
    ®~~ I \ 1----\
    o '\ 2. -t "l-\ i T+I

    . B0\\fVUi\t1 's
    V ( At, Ro\-,) : Mo..x[LA(I\,,-St) + (bCtV(1<tSt,12-t;)]

    St

    Foe ~ ;:>~
    C'
    :
    20

    A~ - h.(A~, ~~.) ~(A~,12t-\)


    Envelop ~r1ditiCi'(l ~ ~. ~ + ~ ~t v; (,~l;St., 12l;) @Rt2E
    ac~ C)At, CiAt;

    =:

    \j~(At>Rt-') - LA/Cel;)

    Vl~l, I2t) -= LA'(Cf+l)

    NOt~) Af tiMe, t, we olOr1+ K-vtOW tlAe ewtvlc:d V' ::) \f'Je \<.Mow OV\\l{ E: [''1'1

    2) A SOll.4nOfl of this opnMiZC(tioYl pYDIo1ef\ll is (A "Sav,'11.9 90Uc~ FYI":

    St ~ v\,( At, Pt-I)

    C" =: teAt,R t _,) == At. - Vt(A t , ~t-I)


    ~

    1'v1e,se, -!1AVlCh'()r1S Mvst ~{).tisf'l +ht 6lAiev ~Qut(tiOYl


    &.. 11Ylply ;-(;u. VDIAVlctON condi+10V1 0Yl C\.-sse-~ 11M
    I t~oo

    . ~
    2/
    4 !3 oq

    le,t I.,t'(c",) -= hvvC t


    lZt '=' CM ~.i,.c:i. l'UVlc;toNl proce.ss ;::::.) 1 ~ i:=12 t ~ 1
    (i~'

    h-v1Vl (1));
    .1-
    Ct
    -= ~~[_1 «.~ C#I

    If- 1Ct - "'(Atl tht,V\

    ~At
    1 =- ~'
    ~ ~tl AWol

    At-+-\ '=
    ~ [A~l2.tl '

    ~ (A~- Cf;) '= 'fb [At~J

    A~"'" 1,A~ ..: (?; Ai;

    Illr;( 1- ~) =- (bl..

    1°
    '='
    1-~ 1 -::::-) O~¥':(1

    \V1is \CVlp\i~ tho.t tltle 0ptiCYIa1 ?otl~ is 1z> CCYlS'UCVle. (/t eDY1staVl.r {?-ac.h'oY1 of'weCltiA.

    ct = '{ At == (1-{?)At; ,'='\tt(A.j;)

    c· c: oltpeVldg on -The. (leW iofc +It\o:\" ,/OlA Vto.,ve, CPet1'ool '0'1 peviod)
    ~

    Fro rY1 itl e. Co nS tatlt\ of ~ A-t-!-\ -::: ,12 t (A t - Ct)

    - 1<t [At - (1-(b)A t l


    =- J:2t [A-t t'\ - 1-t /0")1
    '=
    R.t At~
    'If t:::l ~')
    A1 -:::. (b "cA.
    2­
    -\:;:::2 =) A2 -::: ~IZ,A, = (DR, (~l<oA"J = (b (12,1<0) Ao
    At = (-') ,

    ~t Y'RjA o
    J=o ,
    V t= 1,2. 1 ",
    22

    At ::
    (1-0) ~C-I
    J~~ RJ } AI>
    ~

    Cot
    Cot
    ::=

    -=
    oAt;
    ~-I
    o (1-0)~ 1i Rj
    J"'o
    J. AD

    tot -== (1-~) ~~ ~-io R~ Ao

    3ellMAn'S Equo.tiOv\
    \j (A.,f<- ,) -= ~CD + (beV(At+"r2~)
    ::: ~("6A.) + Eo-f fkci ;
    ~[(1-(b)Ab1
    -b=o

    -== + ~"i()~hF1-{3J~t&/J)A1
    eJ Na~ h etLlA.ili\M \A.M (TiMf, CO(lSiSfeVlCl{)

    t>'tOo.Mi C b-arlAl-S··
    ~ 1Vloev'e, eve, 2 p\Ctl.(e..s 1tI/ 1'10 fOnoWMYless

    /"-...

    -lJ J

    ~,t ).t1;+,\::' g(Ui.t, Ujt)

    }to lJ IVf.V\

    ll.{Jt~:C glve Vl

    '" c,a.m'lO-f ·fY)fluenc...e of !tJ.1a.:\- j ~ooSe.

    No S(,l\(sc,Yibt "V'lct\cti:\'ln9 p\{;(l{€v' ~, j at )( .

    \?/c.- o.,tI .r\al(eys ~(.,e the SaMe g,-mte vaviCl.b1e:-.


    We Vlalle toso\ve E2a0v\" r1ayey-'s prvblefV1 sepat?A.tel'j

    ~ )...., 0 (1)
    ~
    ~
    FOe.: u~\ +
    aU~t d(,li;t

    ..,
    A.
    J.e t ~ ~'(\
    ~l.tt
    - ~
    t-I
    . / t-I

    II
    v

    At-I ': ~ dY", C2.)


    3).(1:;

    At ~
    f.> cw. (),(t... , Ua+l, V\jt~l) ('3)
    Gl~+,
    4. Sho.d..ow ?fiu.
    ITo",,· [,) : \ or; +
    ~1A't
    dg
    alk.t
    r~ dY", ~
    ~l.fi.+'
    -::::. 0 0+)
    24

    Foe: olY'. ~ .AT -- 0.0" . ,. " (~):


    ' .
    olA,,.. + aU,,..
    u",T :

    ." .. ,.' ~

    ~,.: ~T ~
    d~T

    - ~T-' .A-r-I

    II
    'V

    ;\T-I - ,
    ~~ Cb)
    Q»)tT

    AT -==
    ,
    (b ;)f'i
    "9...- 1

    JeT+ 1 't
    ~nl Va . . }(HI:'> -' ~TAT

    AT :- ~ v~.. (),(T+I") C-::r)

    HvfV1 (5), C-:r) = 8'(,


    Q)Ui.T
    + d9 t:J~ V;,( )trot-!)
    ClU,,.
    1 ­ 0 fav p\O'1 ef ~ eS)

    ~\@"~ \Nl~ tJ~evJ Ujr

    I I I I I --~
    o 1. '2 i-I 1'" j-t-I

    (~~r~
    t, '."/ (JlveVl U'T

    rvlWf \I1ot eq,uAA tv th.t, ~lveY\ Ui.T WY pla"{ev j


    ~

    !;q,vo.tioYl C~),Cq) (10) oltte'~'Vle '\W. OptiMal Vo.llA...e~ of LA~T u-:


    ~T
    lJ~T
    :::

    -::..
    ~i(~T,LAj~)
    Vlj L),(T,U:T)
    -;:: k,C~T)
    -= h/).(",)
    i \1t=-o,·,',,'-~·"~ :\'cI\~\"'~l'leoItSI;.
    t'1oboc{l( eoV\ cncu'ft
    lAlI1c;.{}.f~

    ~e polttle5
    I

    )t;..\ ~ ~ C.lAiT,LA~T) -= fC),(T) ,


    o

    -
    NOfe$/1) Eoc"ltl. r'~4€V'S pY1JDleM I'S 0.. "yecur.>; Vt,. pfZ7bletVI."
    Z) The OpHCVlM poli'tL( .fuV1ctlons Vt£lVe.. ~tLf- eVI'u,r-ci"g Pmpevty
    ( 8) l'Jos\J\ fq,LAllikr riuM Cl{VI Y./e COr'Vlputea loy vecw'Slvt (VIetL-tCJd..
    . 4') EacAA pICll/e'f's pro~lelVl' sa+lsfJl'e.s BellfVlCtVl'S prl()(;'lple of eJpHfV1oJ'hj .

    F) OOM"Y1(;\Vlt PlA.l{€V" oo~e (TiMe. rl'1cof1~isteV1Ct{)


    ASSWVlt, 1') 1YJer'e atye,. 2 plo..l{ei:s.; ~ = 1,2
    '2) Pla4ev 2 I~ C\ cioiV11n~Vlt plalf-€'Y" ,
    CH-ev ClunOYl VJCt& ~lqY1lficaVlt Influenu,. On
    Let ptavet 1 ::. FaYMeV'

    Plu'1ev Z ::. G-oVeyVloY'"

    FoY' PlQ,II.ev- 1 : -h-vtvl(l(), (10)


    I
    9r1 + ~ ~ V;1(~T.. J - 0 (12)
    ~lAtr Q) lA 1i

    J.eT+\ - g(lA1,.~Ua.T)

    -
    - ·· Wt1 eye, ).eT. LAZT C\ fe- giveVl

    I'v\ak.e (L~.) tv be. OtYl iMplicit f'Vl ;

    1q, [)('~, ).(#1' Vl.1t, U1t+1 9 lA2 t, UZUI] - 0··

    IVJQV1 1 ?IQ~ey 1.'S probl~WI CCtvt be.. S'olvut, k7v rec<-tr-Sfv6- bac,kwavc;;(..
    • -. U1t = ~(').{~, IA~~) ; S ~ T,'(V1e..- ~isteVit PallO-{ ~ .
    2b

    For PlQ.'l~Y" 2:
    T~I
    { M(}..~ to~t
    T
    "2 ('>tt, lAzt, lAu ) + (b VO~ L).eT+I)
    t\A~T};s. -
    ~,t i.) ).et-rl : 9 (u t,lA zt)1

    ii.) tP (~t, ~1 , lA1t , \"'c1t"':., l.lat, IJ.2 t"+1) ==' 0


    ,.. ~i:(,} .0'(1' ~ ~9i [~ V~1 ().('f-r,)l.· .-, 0
    ~'T ~1A1t

    + to ~t )A.~
    T.,1

    [ ¢ ().(t, ),{t+l, lA,t, lA1t-t<, Uzt' J UZt"+I)] ~

    Foe: Uzt:

    .. . ;

    + .ftt-t - 0

    ~e"e trrW'l Circlt :::: direct e.ffec+ of lAzt (of OlAv' t:. poliC4)
    (t.-W1efl plo.4ev 2 .~ poli'c.l.( ~'> Plol(ev' 1'Vto-.s to Cho."P-~f~ .

    Red c.irolt ::0 JVlctirec+ effec,+ C"ep"e~eVltee( ~ C-~C\iV\ YUI~)


    Foe:

    Sin a.. o

    d <p ('l-Ct-I y~ ~ ...) = 'd\r, ()th1. lA,t-1a Uzkt )+d2g{~~I';U2t_ll #1 ~~ + :l.E. . ~l.\J
    dV\;z.\:; 'd 1A1t-t olA:t 'h.t,t--I oU,t L~LI".. ~><t.D\oI1t Dlifz;J
    II,

    O?

    1hiss\1oW$ -tho.t -tne ?1a.l.je f 2'5 tlCtiOI1 CaYl {Vlo.l'1lplAlt,\:te Plct~ey' :l'S actlOYl ((,{1t-')

    ().},-nCV\e t,-1 throU.91A Pla\{e v 1'S Foe att7(VJe -t-1

    \""I"~-tOI\ _ \hi.> nDt Vlo.l'peV\ o.:t Nash. (;;qlitilib{lIA M


    r"
    VI'M l,l1ttz.
    , I 'I ,
    o 1 t-1 t

    r,f ?\Q.\{€V"'2 CAV1YlO~nCt-s VleV policy a,t -!i(V\e t+2 at t~e ~€0ir1VliV\g

    LA:t '= h 2 ().(~I, ... )


    ~
    OptllY\a-l policy; lA1 t+1 of Plal/ev 1. wHI 10e affecfed.
    ~

    .6. The- I.)otvli ()(lV\t ?l(k,~ey"S prvble(\ll .fa·lls to be Yecu(sive..,


    l--\ev op1iMOl f01iCt1 oIoV1't 8o.tiSf'~ GellMQn'S f\'1f1viple of optiMality,
    ~t.tt) caYl solve..' by £'IMu\1r;lr1eOf.,($ Method.
    At t=\
    '. ~N1ro.
    '-""'
    II
    \A1T

    (Ib)

    Con clu.siOfl ;
    f) Eq,Uo.tiOVl (11)) ~'> The e.ffee-ts of' l,lzt fuy -t ~ 1. 0\'1 vo.\ues of l).1t for s L. t
    &
    01'\ ?a~t Vo.\l.{e. 01 ).(s s.. 'fs()(.,I.A,s, u2S)

    ~
    k;-c, lA 1S oltpeVl()ls Or1 LAzt
    \/
    -.....;

    2..) A.ftev solv'W19 b',~ SystQfY1 ~·'MLA\to.V\eo(;{sly, sne will klllow O?-nMo-\ policie.S at eo.c\A peviool.

    ~) If sne's o.t t~o ::=:) so\ve (1+11 eq,VlClt70VlS -==) '"


    U~;t~2.:::: hll.()(t_".,·}

    if.
    't'~) If <t,\-!eJs oJ t~'2 -==> Solve (H1-2.) equ.CAtiOYlS -::) 1).:,'\;"2:::' h~(Rt--\",,)
    \/
    '...I

    got c*itfevevvt result of' OptiMal polic\.( % £,O\v"il9 dif'fe'fe~t YllAmbe.'f of peviod.
    eq,l.loJiovtS
    ~
    11 (Yl~ - 1 VI COYlS is te,V\.t?o\i c~ J
    ~'1 C~\vo'S C\q-:ri) E;XdMple.
    ~ ~vivo:te o..geVlts' responses to tVJe &ovt to.. )( '3tyZ;(te~y confront {he Govt witVt
    0. V\oY1'(ewr~·I"e. prvbleNl 'IVlc-VIOOS')r19 ().. 1GAX ~1Yi:\,t€-(jy.

    ~ iltlet€l ().(~ 2. ?\ctlle-l'S; C01gWVlev g.. Govt CoWMinllVlt)

    iV1 0 > 0
    7

    0'>0

    := GlAyr€VlC4 to.YYiecl OVey -fYotVl time t ~ t+1

    +0..)( (qubSi().~ bl( *u.. Govt rDistvV'tiOY1 If yJ('c~) .t:. 0 1


    fYli>t1 ~ feeti Mone~ bo.lOr1 Un
    -p;
    BellMcm's fillAuno(\;

    Foe: Ct-;

    M'I7t\ : == 1 (2)
    Pot.-,
    g()
    5 5, oq

    fnv0\op, ~flctifuV1 : "


    ,
    .......
    . ":' .... '.- ..

    \j1~t"4) ~~ 1,
    .1­
    Ct+.
    - - - - - - - - - - ' - - - - - , .'.. , . ' ... ', ~-

    1111S ectuo.fl()Yl t~\\S 'Iou Vlow -tv CiVtooSe PoHcy FVl; c", J. Ctt'l

    - 10'/ fo(Ci(l~ t'hCAt If '(OIA ylttoose c.p 'lOlA lAtin .p,·n~ Mtt-I CtLklO(ll1crlicaJ'lj

    - by 9o.tis.f'Yit1~ &\A\ev'~ COYld,tioYl CloypiC/.<IY19 C#I)

    (0 :: 0,'1, 0" "'" 08

    ...L -:: : OL\" + O.Cj

    2C", tvI-I>tl 1..5 CHI

    -rf '10v. Cthoose C",o.s Po\iGl.( FI'1) t\1efl 'IOU (111\)$+ pick -\tie vo.llAe. of' e«1 +0
    S0.11.f~ 6uley's -==) 'lOlA car1 {inc;. Mt+1 o.U'lvYVlt\+icttlll(

    (If 'lOlA WBve, \'lot pICk Ctt',', 'Iou COI1'+ so\ve to MClX obje(.,hve,pt£:I~\etvl ')
    11

    1
    CtP-t;

    -
    f::U\hAfe- Valw.. of MOYl.e1.( gl,{ppli ed.

    oc •

    .1­ = y Ct; ~ (b.l /1. )


    P-t; J-O \f'~TI

    No'r-es/
    1) ttH ttlnnot olttevM1ne. Pt

    '2.) HH cem C10llle tYJe pt'Db\e M 'oa.c.~~n;J. recufsi ve-LLf


    3) "TVle pYivo.tt, afleVlt MM'llVliu tt-u. objec.+ive prob1t€ Y1 bV (/[""oSI1I9
    Gt- -' (YI-t-t-I 0ive,n tkt.se~lAe()CL 'tt, Pi; (Mtlefe. t ~ 0

    -0
    o •.
    <!a"t's P(Ol?le~t:

    Mo.x ~ ~t lA ~1;, ~)
    il'1",,-z.(~;=o ~ P1;

    I),t. C-t+<T", = 'let.)

    lAMer€.- &-1. ~ 0 I'~ aVl e)(O~enOl.As ~ovt gpeVlo{/(l9


    Mt-t,-I"I1; -= o.Mt of MOf1(~lf ~upplieol iv eCOnOMY
    P~

    I) \his pro'o\elVl is t10t CA. vecuvsil/€, -l!v(fYl.

    b/c fuhAfe, Mt.-j'H '\()·PllAel1(.£. LA (t, ~) of til.e. pr1l/ate.. tAljent oJ tlMe-t'

    ?-') G-ovt CCtr1 \1.ot detenv\1 (Ie. Gt


    1,) Govt hc<s bee.n florete\. tv gpeVict c-~.yye\1.t oMt G-t

    Hti ). tYovt
    - A'{\ eq,ul\i'ovil,.trvl is a. collec-lion of l M\;l-I, 1. t , Pt , C", ~
    fvla.t solve~ Wle OptiNlLAlVl ?m\?\eMs of both pvll/o.te OJjeV'lf S- -the govt,

    - Shte, lJo."'().~: y C'lt) + ~


    Pt
    e,x '2. COVlsiae'i tho-'\" C(VI o'd COMpO-VI,! tno.t Wo.V1ts to rY1CA)C'lfVlize profit ~(VJ {:tVl oi I vvell
    lL 0',1 p.lMf'
    ~Vel1lJe a.t ti Me t f2.\ ::: Pi;, lAt

    Cost 0..+ tiMe t :


    iVI", O-Mt of oil (eMo."IVlir19 'IVl The, \rV~\1 .f-ollows tYJe fecuysioV'\ / -fmVlg",+iOVl equa.+ioVi
    ...c ~mte.1/ •
    'l.e t ..., = ~t - lA t

    - ViscolArJt me-wI'" foY' prvfit gtyWMS tntit OCClAl' i l'1.t£.-u. .fU+ufe


    - \he eOMpO-Y\Y -1\'1+ev1c(S to VlO-V€' +-he 0"1 I well depleted II') 4 Ifrr.,

    (ihe \;JouVlCil.H~ WY1c;fd-ioYl 'IV] itle DVVlQrvlIC Pm9n;:1,vjM'1"l9)

    I-tOl.N MlA.Clt\. oil £,holA-ld.. be. pUMped at tiMe 07 1, '2., '3 -tv MD.)(iMize. the diSCouVlt proB+
    3 I'lL. /,v<; . . gtyet:l.f\II (
    ""0..)< 1-:: p.,t [fllA~-O.09L4l C'\­
    0
    1)..1 ~1 ~~·o
    g~ t.
    " I....
    ~-t, -::: ~ - lA~ I"
    u,? v.,}
    ~..., ~. t 1 -,. ,.
    o 1 '2. 3 4

    v().(",) = Mo.x tPt'ht('~(t) - 0,05 [h",(\.tt)] 2. + f.>V/{).(t- It'It()tt)](


    IA. ~

    Foe; tAt :

    Pt h~l).(t) _O~1 U4:·k\~()(t)-+ ~v 'C).tt-t,) [1- h/()(t) J


    h~(~t) [~-=O'-1~:=-;~~;~1 + (bV~~t+l)
    ...... 11
    o

    (2)

    '= 0,1 Vtt 4- ~.±: V/(~'t)


    (l5
    ::: 0,1 LA.t 4- V '(loft)

    l),t - 10[Pt -V'(}{t)]


    ~
    I
    e?'~, Mo.x Z ~tC1-'{)Qt
    -too
    g,t, Qt + ~~ = k~

    M(AX i t~
    ~-t C1-0) Ck~ -)tt)
    ~.t. ,kt +, '= (1-b) kt. +).tt;

    k Q gIveY1

    VCkt ) - l-'1o.)([(1-r) Ck.;c'-14) + (btV(kt-t-,)]


    )(t ~ 1-\ (14) ~

    FOC: ).to\>:

    ){Y = l).to.-).iO.J + Klj


    -::. )to.. ­ \-t [(A - 'ell
    ~ 0
    - v

    (Fr)QO k:·' + l(I-b) (1-l; - (1-b) G~~~Y) ~t;vt~ t


    -
    (1-'0') [oC kr + 1- S1 - - - - ­
    = '

    (2.)
    Rol\'l (1) : ~t i~) [eek':;.' + 1-$1 - 5Yf'}
    ({: k'tot
    oC
    -'
    I = .!._(1-~)
    (!1

    Ht-(H)1 -'('
    "

    ~t, - 1 .
    00
    '> 0 ( ~)

    At ste04.y Stv-te,..: k-t.t-r ':::: kt = k'" - C1-~) kit +).(t

    k" [1-6 -cS)]


    l<
    ).lot; :::::.
    - bk* (q..)

    ~
    j....
    . . .l·t ::
    .[[~ ­ (1-0)] ~r' > 0
    tP

    =' ~ckn

    .0

    Iv'Q.X L
    oI;~Cl
    ~t ffi Ct

    ~.t: Ct + k t ... , ':: k~

    v (kt ) :: (\;1.0:)(
    ,1';~1
    l~C-b -+ ~ v ,)1 (k e..

    :: ~o.x [#A(k:~\<t+,) -+ ,6V(~i)J

    1'
    ~

    VCk\»

    1
    ~- kt..., //
    /.
    ,
    ~.5 rvt lkltl pevioot Pwbltf'll of tl. l'"epre~entat1l1e eOY7fWVleV- 1% tmce.--izf,Vlty
    I I
    Mo.\( I. ~-t, U(C~) 0 L. T ~ oc
    .c~ t:oo .
    g,t. Abti = R-t,(A-t-C-t,) 0 ~ (6' 1

    Ao 9lYe-Vi

    Wtte(t lA(Ct) ~ ~Ct

    1.1) {!uppose.-, t.,.,. "'f-1 wtite ti.1e '(emaiJ1iYl9 prvbleiVI of tni~ rep(eseVlt" COVl$UfYleY' at T-1

    fvlo.~ [k-C-r_1 T ~hc'fl


    Ih., 'C T
    ~. t A-r =::: R,._I (A,.-, - ~-I)

    Ar-t1 = gT (Ar-C,.) == 0 => A,. -; C r

    ;t ::. kc,,_, + f.;~c,. - A [0,.- 12,.-1 CAT- , - CT_1J]


    C,._I .. i - /\ I<T-I .
    Cr-I
    ~
    ~

    1A') -rind EV\\ev" tonoition & the OpHMM COr1SwYlptiOYl poliel/ o.t T-1 interN! of c r t(8, rz.~

    J,... ~ .1..gT- 1 - [u 1evCov1c/,h'or!


    . C,._I . C,.

    C-r-l = (f-i g T_,f ' CT


    -= ((b12.T-1)-1 AT
    -------.----­ ----

    CH Asse,t Pt'ice o.rlcl CoflSlAMptiOVl


    ..,) -l7J ec.ppl"1 recur.>ive, siYv\ttUt"'€,.(1,v itle COl'1st~cti'OY1' of CDYlrIAMp-noVl g,. 'ossef ~·u
    *" ~ bV lAf>itt9 ElAlev3- tv qe~emte Asse-t f'J'ces t. ConsVMptiO;' "fheotie8. . +heOYie&.

    cO
    (vlo.x E" 2: ~t v..(C-t.)
    t=o .

    ~.t At+\ ={<...,( Y't + At. - Cot) .

    Ao g',veYl

    EL(ley~ Cbtto.i·/iOYl (1)


    Uet p. 1'1-20)

    . 1hiSttluatioVl prvvio/.ts #u. b/Uis wy severol 1tJeoYle&

    't") !"+cdl'S r<aVlclf>1V\ woJV.. 1VJ{WYlf of &vtSU€\J1pti()YI

    2.) Ih~ f?;tVl.dOM W~l [I.. TheoYlj of gtot/v... PYJ'US

    3') L.I)Ca&'s MocW. of Asse.,t P0us

    ~> &te<te v.

    .
    . ..
    o 1.

    '101/1 will k-V1ow Rl; at tW. ~e~i(lV1j ~ of peviod. t+ I


    Cvov.. Will V10t kvtOw I2t at tiMe t )
    D.ge\l\t \s boY(owll'l~.
    @ rtall"s t<andotvl wall£. 1VzeofL{ of C!MsWllfp-h'Ot1
    1
    FroM (1) : [ E U'CCt+l) - ((6 Rf LA/cco\;) (

    v..\tJeve, !<t:: COflSml'lt s. yisk-f(e.e. l<o.-\"e of ~tv..( n (~ ceV'to:ll)~)


    I2t :: 1< >1 vt

    -')Mu %lIows 0. UVllvov'llAte -l1rst-ordev Mo.ykov Prvc"ess


    (;1,vl(t that VlO OfVl€'f vo.,v1a·b\~S \(1 "'h~ info set 'neAp 1'0 t)'(e(f,cf lACc.t-t,) 3
    .... OYlc-e -\etgqecl u'Cc-t;') V1 os 'o.et1'1 'Included.
    '1'.i,trl·IV~irA:\;r-e-: fCoO~oC)
    rVIlAI-hVClriale-: h.(d~g' l cl,9)

    e,..

    ® t2.l\rlO-oM Wall<. 1heo\'\:f of ~+Oc,k. Pw1as­ C

    Let rL(p~ -\- cJ.~,) So\; ~ At.


    - I­ v govevrwt I:y ()t MarkoV proceJJ
    vJ.'1€r€, d.t ::- rvYlcJOIYl ct",v',oUnc!S of CoY1SLlMpti0Yl 90ool; ol..,~ ()
    Pt ~ Pvl CL of CoYlSUCV1p h OVl tj0o(J. (Pda of .! have)
    St -::: tl: S VIQ,tes oitlYled. by 11M COl'1Jl;\fY1ef 0.1' tltle,. b~',I)Yl; (I~ 0t -t

    At ::- Assets ~~ a ShCcfe. +V1&tt &e.\\S Wt R ((Vlecwlt\re.o. in COY1~VMpt\?v1)

    <;t :0 Si;+1 = 1 qooet­

    = I f'cs,cl) ds
    o
    L----~-------
    tr-M(lr(l, olt IS ~()veYyU..cJ. b.t Ot Mo.vkov ProceJS '1- 1101e il1vo-Yia",t ~t1SiliOY1 c;t..e%\Si-h-j
    ? f(d~~)
    (~l;. -+ Ot) 0:;0 Ar.se:\ 's pO-I.{O f.f - (0. vo..-i Ct \;)1 e,)
    \l;tVlcJO/Vl'
    '. Pro II. (-:l.:L . ...I ~ I ~. ._ ..J ,\- 'cleW Ii1filW.: "'1 c4.
    • . U' (;,\\>+, -.~ (;,'.~ - r:A-I' .. ,(" .

    ~ oteVlOteCl b.t P(o.t+l) iV)te0mh'fl~ ~ o~ cJ. '

    ~"

    o el'
    . ::\
    .'. ~

    • I
    o 1

    froM (2) :
    At"" :::. <;t-t'l (?t+1 -r o.tT,)
    _._... _~s ..v...
    l"'"roM Be. : Atr<\
    -::
    \2.~~~~A~~ .
    ~t+1 (P-t-H +Ot-tl) -= {2\:;St 9l:­ •

    12-1, =­ ~ ~tkl ~ lhtl)


    r~ p\,
    1,1,
    ~
    v.'CC",) = ~ ~-t l2. t V\.'CCt-t,)

    l,A'CCt) -::
    ~E-t ~+I ;tct~~ i).'CCt-t,) ('2)

    1
    1­ = ~ ~ r~' +P ct«~ l~\ct-t'~
    t l)..(Ct)
    Euleyls

    1 (4-)

    6'1 the 12l.4.le of E'I<pectCl:\ioV'\ of procAlAc,+ of '2 Q;l.V1dOM vQ,'fiab-tt.~


    Lf ).t, Y Me.. rov1{;tOO1 \I~'fi ab-U-s, tW.V1

    fE~[~yl -::: ~t[}(l Ett~1 -+- c.ovt[)(.yl]


    '­
    WtteV'e.. C.OVtl)(, '11 ~t ()( - Et}.t} (y - Etl:l)
    E
    40

    '{ViO AS~VJVI?lri(]l1S of ~n~olY\ WQ.\K TheOfl.f of stock PriUG;


    i) ESLA~ct+,!l. is COYlSTt\V\t
    LU.(ctlJ
    \ MU \2.C\;110

    , - rf

    -,} lANleVl 1'ne. shave, t>rlU is o..cAju.stecl -roy (fl'v'id..t.V1ds£ d.iscol.l(\ti0~,

    't'\- .f'vllows 0.. -" first-ord-ey LAYl·'va:via,te. MG\V"KOV prvUJs:'

    (CCme. -FtuM (e,Ia\'i(JY1 P-\; S. P*I ')

    II
    v

    ---') mM ~ ~l1Aph1 1-\\-\ cADe~r'+ ne.t.O, tv Iou~ 'I()W~r1ce-


    % t<t ccm ~e, defeilV\inec\ by e-IilOOS,f18 opt\M!M. fullCtj Fv1

    0'1 d.e;teiM·'l'1ing Asset tYtG\t (Af.fe(.+~ FUnc:40.meV1W of Asset


    ~

    i-his wll\ cktcW'''lll''le Ii

    <>. \2.iSK \JrQteV"€VlG£,. 'Inc\v.d.es 'IVl tne Lthlihf -tn.

    ~lAt 'It QOesVl't mlCtte,et -tv ittle. ~tate vo.v'io.b-tt-,­


    41

    ...
    .}
    ..

    P" ~ ~Et [f-JEt:+, [f1~1;-t'l. (Pt*"i +cll>t~) +c11;+21 + 0.1;+1 ~


    f\ -= l~\:;tE1:+,E1:-t'1.P\;-t~+~3EtEt+IE:tA-Zcltf3 4- ~E:tEt+,dt-t'l. + f2'e'"d t +J
    Pot = (.1\t JiM [~j Etet+, .•• Et +j _ C{{+j)] + i ~j E..tOo t +S)
    (b J .J-:>oC
    1
    II="
    (b)

    FwtoL«""et1W of Asset Valu,(. C~)


    (5,tlev -+- Q. ArSWVlptiOYlS)
    '?
    1his sholl'lS No II blAQole"; in-rh'l~ caseJ (no·vt +.)
    - A COf\1rv\OYl lAsecA. torlVl\AlaV' \'!r1ki"9 1J.\t\Me- priUS. "f e.x:peGtect -RAhlve. C:fIV'lcttVld.S.
    -r.f COlYlpU)'\'f per-Foym~ well -==':> Pt1
    - 6ubbles rlAleol out Vy lASi'~ the'lmV1svet'JOlliht EbYldmon s. eq,Ua,lZM'vwI eonditiorl St= 1
    \~ -
    Col1cLu~,Ot1 :
    PI;. LA(cc~)

    Eq. (&): iVle MU loss of tonwMiflS le~s +Vd.a~ $<. buyrn9 IVlO{e.. asset shof,tlct eq,l.AtU.
    ~tf>v..'(C*,) (PI>t\ +~I)
    '\W. (vIU ~G\.IV'\ ofeoflh."Mit1~ MO"e c:use:t-!>s ptllfDf'f IV) -title. future..

    If Et fu'CCt.. ,)l
    LU'CCt)"j
    is not COYlstall\t) itLtVl \
    ~
    e,asic P~clll9 (g)
    9ttc.<ttta'OVl

    --OJ lhe o.£,set'.5 pylce. SVJoulc{ eqyo1 -the elCpec+ed. diScouVltecl vl)lue. of
    -th~ asse-t's ~C\.yof.f~ US'f19 -rltle MU -tv c;{iSCOt..o1t tVie pCll.{off

    ~ A", 'I(\Ves-\()V~sF"OCs 9'\Ve tVJe. 'oasic "c0(1?>(,lM~}n0t1-ba5ecl tvlocUl:'


    04 •

    Pt == '5; ~J u'cc.\>+j) o!#j ..- bv uS'l~ fuV\~ve-rsMlllt ~ilioYl


    Ji'1 (,lice ~ .
    or ~jlVl ~J Et ~'cc~) Clv>j StA-jl = 0
    J-)OO C
    !,<,'(.t. 0 f skA...",
    @ Lucas'5 M(1~el o-t Asset PYl'CLS .

    ~ 1vtlS rVlocUl lASeg -the ~eVlem..l SquilibriuiVl concept,


    N Asse.t PYl'c-ifl9 Ft'\.
    AssuMe} -t,.) 'It:: 0 'v't ::::-'> No procl Vl fbr tAlI pe.,;10C<S

    [;Ii} lVIeve is OVlIl.( "o.uro.ble ~oool" '\(\ tne ecofICMI.(

    := CI. set of fret.. .~ 'it: M;tt11!

    At -\1(IIU. t ~ 0, V1 e ltto. ~ 0. tr€.(. ..... Ao ':> 0

    ~e;t('lA. peliod. .. ~e. CDu,lo., have. k t toy' o.\loca%ion


    At 1;, If \'Ie eOYl$WVle.g ~
    . -.:;0).. Cot > 0

    Ar,..\ =: At - ct
    :. (!(iI'1s~eV' \i'll'll o.llocMe '\i.M. 0Mt of eOfl£l,.(Mpnoy\ oJ eCc.GlA. ~e.1()d­

    1-0 Mo..'l(IMIU V1IS u-nllh-t


    ~

    ~s) f At-+\ ~r). Ct (Me cofliYDI ~~yja~g"


    (At 1$ S'ta,te, VOv1a~ (In PeilOett) .0; -\1ALre,l\101Y\tf(t,
    lj .Qvl\il I Gut r€JI'otJ...
    V

    woAd­
    .,
    L~~} Eac,,!A. petioo.., eo.c-VI. t<a yia.\c;tg d t tv ;{.-u.OWI'1€Y O.t the. be~iV\V1I~ of t.
    "!;v) P t :::. p",(,t
    .
    of 0. -\Yet

    C. to.c"Vt a~I'\-t· st7AV'~ \"Fe at t::: D V'f 1 trf,t! ',-k; ",',haL at ivid.LVld ; ~uit
    "..,

    6~~~ \
    ~I---+-_ _l------'-­
    011.
    4-3

    lAC·) \s stric-r\y inUCZCtS'fl9

    o.t is W onl\.( i source. of' qooo(.S


    ~

    Pt; -= Et; (?> LA'Cd. t ...,) (PHI + dt... ,)


    . lA/Cdt) •

    4 MU (Y1ot COt1~IIMpn~) is tVI.L funola/llleVlta..t fYJecol.ltt!


    of how 'lOlA f'eeL /
    '1M 1 owV' ·h'M,,- I V1O+ coYistZlV1.t. 1 •• • . .
    .j -If Ct IS low ='> Mu 1$ /.11~h.
    l ,._ ----.. '/
    \ 'V
    \ we e><peL-+ Pt> +0 PI!.- low .fol'" as'e~ j
    \ --..~//

    ~ IS 0. gel1erttflOfl of (q) In W-tll'ch tGe Pt , I') {i\.v'\ expected diS'counted gtyearvt of


    crlv~ct.e,(Jcts but.~ tl£V1~-Vo.\'I.('''9 &-. stoc!AClSh'c disc,ouVlt mte-s .

    Tn t~is case) c1t t-j .( eli;


    ~

    et
    l).'CdHj) > 1
    Ot;­ \)'(cl't)
    ~ ~ <101- C\ ttMR- diMliVl,iOV1
    44

    .c
    Pic :=. ~
    J::'
    ~j E.tLcAtl

    I
    ~ s'\ttre, v,
    /
    12
    P,
    :::
    L
    1-~
    cAt
    [
    -1I1is SVlbWS preseVlt valLU at 11AhAre- vQLu..e. of divj(j,tYJoU ?
    - Af\ Asse.t ?t'icl" FVl CiA. fV\ ofdt)

    ~ lVIe AHetP.0cifl~ FV\ IS a. kelf -to cleJiYle, the; eq,uaiWutV1 of tW. '(\I\od.el
    ~ 1<; a view ClbolA-t 'It1e, law of MO-tlon ovev tJ\l\'1e of oI t g.. Pt
    ---) A~eV"lts !Ave (?uppos..ed tv kvtOVl ~Vl (;tv~cJ, law of MOtioYl wY ot­
    ~

    tWVI) 0.. tow Ot MOtlOY1 fv~ Pi; ;s- olso perceived.,


    .~. The. 'vWftOY1 of G. mtJOYlM elCpeCnoY1S eq, ullib>1UM II~

    AchAw. pilun.e FV\ ::0 ~eYcelved. Pv'ic-t\ft5 FV\.

    £inGt. i) All a.0{\Ylts (ve., ',cUvdiaJ. =) o..ll COYlSWVlert· ltIo.ve tW. sAiMe ?reft?re:Yle.t &. e.,c(owr~l{il'\t..
    0" The(e cu(! be (\0 ~D.I() -fiorY\ tro-cU.,

    2) dt "" ffiVlclol'V\ VOvlo.l:;h. VlMfc,,1A. ,'s ~o\Je(V1ed ~ 0.. [It\lAv!o<OIl Pt'llcesS

    '1- tlme,-irwOY1OeY1t lrt\rlSIn'orl Prob. I ""eVI b


    P(~:h(ctt+, ~ ){/\c4=~) -= F(~~)t) =

    '3) llt:O Sttl =' 1.[


    t; :jr +(e,L ovmecl G\t '\W. be0lYlnlMj o.f t
    S~(Q;'.l J
    4-5
    !7 oq
    .
    - .. - .
    .0

    ~O-)c Eo 2. ~~ u(C~) (10)


    t~o

    g.t. Ct + PtS~+, ~. CPt +C4) b't

    f(\'( off : A-I>

    ObJecfJve. FYI: tells the.. iYlves\Vt'" 'ImpC\ti€vtU,. J,. ii1e i vav€.,gfoYl -to 'fIsk
    1

    (The... wV'v£1tu.(e.- of '\W. uti Li\vf rV\ genernte.s- aveYbiDYl tv Yllik s..
    1

    to \ntev-reVVlpOaJ., ~ub£tihAtiov\ )

    .
    I.

    1 CoI15t0.",(V\" n,~. 1VIe 'Investoll" eQn Rretllf Out( Ise-II as MlAC.lA. 0+ tCu.. pa'1off as ne hI'SItu.S
    I ~ ~~

    A: 1I1e. inveswv IolAY: MOle..lless of tkL asse.t until -this FOe /tlOld~ .

    .L Pt '= hCc(-t) 1 bevomt. P{)'Cl~ ~ of s!'t-te, v.


    C<W1(?fe,. k l~ cOl1fiY1u.ou~, bounc<tet ~ cuAinect
    I 0(1 tW. w«e.lld 8rnJe- v.

    Not~ Asset- F\1ci~ rn.: fit = VlCdt)


    T~V1~itiot'\ Law : reef cl)
    ~

    .~.
    L-et cl~ = ~

    <?lntL CR + ci~) == Y'tlvtdOM "o.v1e;tb-t£,

    A+. = g-t;-( P~+c4) :;; S-hAte vaviabtt..,

    ~.
    5' [hC'I<.t) + }(t1 = Ij+ttte, vo..YiCl,b&.

    I
    Foe: S;

    ,
    6V1I/e,\op <?VYlvtI-hOYl; v't S (.)] - v.CC) (1) = U'[C(~<)]

    v'[s'(·)1 ::. U'[C(~I)J (1'2)

    ~I
    -....J
    "

    fuNl (11\ (12): J(c) n<),(.,> ::::: (& JU'[CL).(')1 (\1<).('>0+-)(.') etF()<~)

    vLJ

    At ettlAilf~'u1\l1) .....~ ~ S' =. .. 1­

    1
    1/

    =: (6 Jw(~)cl F('I(~l() + ~~ l).'cJ.) ~I clF(){:~)


    ~
    (IS)
    ASSUMe., .~) He. cAoes YIlt ~OY1SUMe, c:lVly-thiI10 in t~e. OY',~i~

    , Vt~o) -::. 0

    &l S ,,:~ vi)


    ~~) IA(C) is eonCCtvt &< bouncUOt: by.'. 6> : . . , .if..'C)9..') --'I 0
    If
    CHH is 0Sv_ C\.vef5ive.,)

    l't1Vl l).1 ().(./)


    =~

    l.(/~o
    1
    u'C)!/)},(,' ,,-' B.
    I. Ii 1\1 IA/(~) -= 0 ! . os
    '", I
    ~~O .
    )l~OO .----'------'""'\\l~)f/.{)..,,-otJ.

    ~S u./()~') ~ dF(~~){) =: (3f! ....

    l/

    '"

    ~ mi.s E:u.\eV".s eC(,vaticl'{\ IVletlC£lte.S "S~oV't-(a",., f3't~,liloriuM~


    ~

    --') ThiS eq,lA~hO'n ;s tVu.. forM ot Actual ?tiDing FV\..

    Nile'fe, hj...'o.t) =- tlc.:ru.aL pri ch1B rr'\.

    h
    J
    {.}.{.') = perce·lveo.. Pn'ci~ Fvi

    ~ JYI +Iru. SVlO'ft fuJII, v-ti+'().eJ (\ileA\! not eq,I).AA lttJO<")


    Gin(£., eq, (l&) q,hows £1 (\AapP'\r19 of ~j('It') 'wrID ~"I(.).()
    ~

    A f2.D.+iontd E~peCmnQ(\ 6lt(,4.\\i~(,(M


    at E
    . -'-'is ().. fixecl POlr:.:: of thi S MappiV19 -hro1Vl hh~') +0 \t1j,,"'c~)

    At equ.1"I i L .
    t'(Il'1lAM , \I,J I '= r I
    n 0<.) ,~j+'(")_l
    Y'-_
    L-_------:
    1) Asset L;upp\l{ :: ASset DeM/ulQ..
    '2.) [Vo \;IOctlf eclV\ 'cleo-t ~ MarKet

    At pOint A , h~(.){/) ~ It\j~'().(.)


    l'
    Not~ ['Jo expec.tect vallA£,

    - ~J

    Asset-P(l'ciIl9 F,,: Pt = V\ ()(t;):: hi+'()t)

    ,.ml'lSmOrl Lo.w : Fe}(.: )( )

    \1·
    ..;,;,t. , ,

    define, the perceived L.a.w of Motion foy ~jol)

    . . ,
    , , ,~. ~ ...
    c) Firlit-e - Sttltt, ve~ioYl of I,Ltca.s 's Model . ,
    9UI/PDSe-" l.-) There ~(e ol1llf '2 st-ates ',n;:ecu,lt\. peYiod(. t­
    (;0 \)iv·,d.en(}.s hONe, Q possible: vallA..(...S; cA, 6;l)

    ~~~) T(Zl.YlS·lnon Pevb. Vist. i5

    [,",rob ~t-t\ ~ de lett"" 6,..) -::: P"'\3 / '> 0


    trM-efe.. (t = 2) for B
    C.t=1) fbr' A

    l
    '((0'0

    ·~l
    ~
    p ~

    ?"
    P2.\ P2.~
    2.~'

    1 :=: P" + ~~
    :=:
    1 ~\ + f.;...

    -P­ 2.\
    -0\­

    -~.
    t~o

    At t : 1
    A=1

    At t= 1 Z 6 _

    A '" 2 _L_------ _.
    2
    -. , , _ ., . . . -'_ _. _ .
    (~(~lAl{6~) == ~ fPz, [1/(0,) P(a,)1 + Pl. U'(o2.) P(O.)} + _~ ~'LllA'(6,)6J+~. ElA'(6.)6.z1 ~
    ._-- - -, --,- ---.- - ---------- - - -----..-.-------------­
    @ Asset PriCifl~ - fvto(e Genemlly . ' .
    A') TerM Stn.tC+ufe of Intet'"est R~s
    (".,Ctfe. \OClI"I)
    -~) 1Y1efe, are.. Mo.vKe'\! 1- PeYiod 'Perfee-ttL( sure.. cla:IM ",' Mo.vket 1
    \ .

    2.- Period. Pe'ffec:t\1.( 'iu:re, cJaltV'l Ma'(ket Z.

    m t<it- = visk fr'tt. rote of fefum BrO(Y1 (V1(;wket 1. (o.re kVl()~ VI

    [(zt -= fiSk ft'u..... MClvket2. ) \.N/ certO:J>1-hj (;\t tlIMe, t.

    1
    ::

    ;z.t
    J- :::
    ~zt

    Fo\" Market 1 :
    Asset ClliHl'\
    i1
    I
    o 1.

    ~
    ..
    '1 *1xR a
    I I I
    012.

    \
    1his eqUo.tioVl heAps YOlA+o cltcioU- /AMiclA l'Y\Q.vke,+ V()lA W~V1-t 10

    PlAt '1ou,'( rY\Of\e,~ '\(rrO,


    ,51

    HH'S Prnb\erV\:
    fY\o.)( Eo i ~t lA(Ct)

    g,t, c~ -l- L,t" -l- Lzt ~ dt + L,t-. R.,t-, + LZt- 2 r<2t-~

    i ~

    i..

    Foe: Ct . \,A'(Ct) -:. At


    ,
    L,t (!:1 Et ;\~I 1<1t -= At
    2
    Lzt ~ Et A~z. \2. zt ::: .At

    (S)

    fuM (~)) (1"):


    2.
    (b Et
    I
    LA (C:t+2.) 1<zt .- lA/Let)

    I
    \
    1- = ~ Et [LA '(Ct+z)1 (b)
    l3zt . U'C.Ct)
    I

    ~. let' u(c) =. he.


    d.t .,;:: Cv

    ~t
    1 = ~et [Jh.
    dt+1
    J
    1
    \Zz.t
    -= ~Et~l
    Ot+-z.

    -['
    J /
    l /
    NtleVt P> 0
    is .
    0< EJv ,( 1 "sequet1C,..t of ineupev'GLtVltll( & idtVltieaJIL( cllstv'lbuteet '(O.'(1~f'I'I vtlvia,~G,$

    (+)

    \(l're (e-,·r 10\:\ e"


    -it
    If p > 1 =='> f<1t 1: "t the. teifYI tv jV1t)+ur'I+Y
    (3EJe-']

    If P <. 1 \='> R1t L ""/ -\t1L -refM


    I'~Je-1]

    (>0

    ll2 zt > R1t 1,


    ,~) lZ,t J.. R2 t ave Yisk tv-e,t gross rote. O~ ie-tLtyYl

    9--(;, t\rley o..ve.. tlne mte, of re.tum o.f perfectly ~Dte 'oaVl~.
    ~~) \ZIt 8< ~2t ave o~+o""r1eet. ~M tVle, eq.tA. lilot1lA (VI of tkt eCOVIOMLj
    '
    "'?- ul'\cevto..'lY\ tu-h.<ie. cflv i cknet.s.
    83

    (Zate.. of Retuy.-(\ ~ u~ce(tai()ty

    LetE.., fi,'t+1 = 0 (tYle least ~qlA{l(eg resic;{,u£tL)

    ~ V.'CCH1) t<1t == 1 -+ ~I
    lA'(c-t;)

    .. ." .-

    ::::.

    Will1tt 't.,t+1 '= p., lA'CC-lo-tI) ja1t - i


    u'a~)

    This e.q,uoJiOvl is a verslOY1 of P(,((e. E:Y\pec:ttltiofl 111eoflf of -tl-1e -WfrV\ 8hlAc,:\v\fe.


    of 'IVlteye,st mte.s, o.c\j\A~teol -toy- -ItJe- Y'ISl<. p(e.Mi UM COV-t.- (.1- , <iI,tTl)'j .
    f2,t+.
    If COVtlj-,
    I(.,tH
    tt1t +) <:: 0, -;;') , 1itJe ~~v.it J$. visk. aver~h'e

    If CDVtG 1 ? '11t.••) ') 0 -0') -me a'je Vl-f is viS\<. loveyo


    ~

    If C.OVt, (f-- , ';"t+)


    1<1t+.
    := 0 -;;;) '-\-he a.~eVlt 'IS y\~k 1\etA.t~\

    D • .1-
    l'!:zt
    :::: 1
    12.1t
    ~('1~l 1 ?{.l(e Exp4'c.i"a+iM TheOt1.f C10)

    ~ 1. If \,A'CC«-l) -::: 1
    U'CC1)

    #1eVl, 1 -::: ~E:t(1) ~


    f.21'l:
    ==
    ~

    covt, G-L, <!t.t.!-)


    I<.t+l
    0::: 0

    ~ '2.. If ~1t-t1 = 0 ::::'>\ Theve.. is no uVlet:vt",iVlty

    *u.1'l, Covt (tt-t-,' '1,,<+) = 0

    Co;. Y,Sk prel'll'I<.l(Y1)


    ~) VIS\<. o.ver)';ve ':=:')

    t{;leVl , '1
    R:zt-
    -= 1.
    '~t
    ft...1- 12, t+\
    + COVt~l<1t1-1i , ~1t+01
    ~ )
    ..
    1
    ~"
    <:: , E.tb 1 1
    ~t [2.,t.1

    «zt '> \Z1t


    'r/
    s<!.t(~) ,
    - ,/
    S'et (l))

    If
    ~,i -:=')
    ,:' ~i;t .~,
    ti(C~I)
    V.'(C~)
    '1: -:;'> £'1t-+1 ~
    55
    g S 6~

    ~} c.on-tif1gent CllA.irY\ Market


    1) . One-Step-Al1ea,£i fi«tt~CoY)tifl0ent Selurities
    d.yt-'
    AssUMt.,} . 't,J All Info CtviAilable, t1..t t -rhM Vlelps predict futur-e.. div"OeV\ck
    . . I . .

    \,D ).(. evolllf,S Ct CCOY'Oi (j 9 tD 0.. ~t)rkDV P(DG~S desoi bed ~1


    1"rnrlsitiorl OeVlsity -f()t~)(.):

    Pw'o (~t~1 ~ ~' l ) , i t : }{) = ff(LA)~) ct


    ')(.
    V. - fc).€: ~)

    i~~) [d I
    t =" ~",J ; s+r.tte, V.

    CUl"(eVl1 (1\1 V"I o(R,"'cl


    H~ C(;m plA@a~e. / se,ll 0. 01l\.;1\11 to 1 (,tVlltofl nel't-pe.1od-

    eoY)s(AMptiol"\-~ood...- COl1hntttV\t 0Y1 title eveV1+ tVlCl.t ~-t-I beloYl~S +0

    ~ ~e,t A

    '~v) 8(;"'~} := ~hAte, ptle.t =1= 0 (


    .for n"-'t gtztte. V. .
    -t;..-I
    C'" C,Mtlrt7t",t C-I"i,,,,)

    o t t+1

    'J) Arrow - Debru.- seeurit'l


    .sL = ~ }{1, ),(2, ).(3 ~ - no fYlGlttev v41Ctt h~ppeVl,
    YOIA. Wlli qe.t fVIOY1e'{ bCi."v.- at HiV\.L t+ 1_

    A - If }.t,z occW'J ",> you w11l not <Jtf (\AOYJe'l


    betc-k. o.t firm t -l- I

    A C ..fl.
    t 1".
    ea>'lHIo/Vl~ ClaiM 'Pert€(;t14 Sure Cltdtv'
    0Yl -10+1 0Yl t+\
    56

    ?riu of.n.. :: q,C).{,,).() + q,()(3,).t)

    P.,1c,( of A :: q,C).{,,),{) -+ qC..f.2.,),t) + q}}(3,)..(.)


    J:!J
    .. (=: IZate of re·hu>1 of ~iA{e- CACti M)
    Pyiet. of Perfec.tl(,j 9l.lre, tlalM a.t t ; (SeJ.- p·50 -51)

    I q,
    )(...,€ Jl.
    ().(i>t, , )(t) d l-et +1 -

    .....
    .. p ,,' .",. ,.e1'1') .
    .. . .
    , ~ ., . . :~

    (12)

    ~ q,. (U~" ),(10) d ~t+1 > Jq,


    ),ltt,fO.A
    ().(t-o-, , )( t) d ).(tt-I
    I

    ~1C..n.

    ASS(){V1Q;) VL) lYIe{e cAye" C.OMpe,titiVt l'Yl{lrke+s toy "O"e.- pevioit coY\n~eY1r Clo:, (y)"

    1-'11-1'$ PY1;lble.M:
    00 t
    Mo.'X ~. 1. (b v.(Ct)
    t~o

    t;.t. Ci; -+ Pi; St+' + JqC).(H, ,~t) '/(lR~l) d ).(t+1 ~

    ~ (.) ~ Pn'C(. ~ toy 1- Step- 0. \tleo.ct (0rl+1n~Vlt c.lo.·IIYl&

    Y(){t) =- COflSl.lMpI1OY1 OYI CoY\1in1'V\t Clo.\iV\ 0('1 vet o.t tiMe. -t-1
    S't :: ho\di~ of '\1' u.s Cot
    .
    ~(V(>I
    S~

    . .) / f't ~ PC~)
    ~of
    Stt:Ate.. V.

    i
    dt :: d(14)
    o I I I ~
    'I (Y- t )
    CI;- ... C-(l4)
    t?:'e\\MCtr\'S E'qlA{~:tiOt1:
    v [(p -+CiO S + '( l)t), ).-(.1 -::

    'Foe: c: LA'(c) = .A (14-)

    s' : ;; J V'[(P~d')S'+y(}{\>{J fl}l~')(.) (p'+d) d.\£.' = AP Cl5)

    '1('-i): - ~ J v'[(P'+d.')S' + ,{l)(') , ).(1 f(),{~)t,) (1) ¥ :::. A yq,o<}(.) ep.' (lb)

    EV\va-top CoYlc!itiOY1 :
    v'[(P-td)S+ '1('ot),~1 ~ .A

    .~

    froM (lb) : ~ Ll'[c(:It')1 f(,)(',)ot) :::. lA/[et).!)1 q,c:~',)t),

    q,().(',)() - ~ lATc()(')] f'('~t~)'()


    u.'[w,()] .

    "This ectuQtioYl call~et ")1- step- ane~ ~tatt.- eov)'ti~t ?-J'CL P'Vl'~
    - AI\ Ctsset IVlDrkets (YllA~t l?e cletAv g;(\IlulmYlte;u.£ l'f
    - ~'IMllav ve.-wlt as LlAcaSJs Pdci~ Fv1. ibffVI.
    As C(,)(.) -== clc)() = )..(, ,wn
    ,..--=-------------..,
    q, (I-<~)() = (b I)'(),(') fc)(~)()
    lA'()(.) .
    FffilVl (I'~): Consider- the. piece of the. LD.9(()Y1£jiaV\ ',vW0 1Vi fl9 IY)te9~not) OV\).(.'

    '1 G [){', s'~ '1('~'>, -1('1(1); qc).(:)(.), f().(:)(.)l~' . .


    == ~fV[[P('I(')+cl()(')1s'+ ,,/Ot'),><-1 f()€~).t)sht'- AJqOt~)t) Y(\tI);JM' (20)

    WrIe(!. Y()i.') ;::: 0. Y('>t ' ) .


    Ci)7

    G(·)
    This pcvbleiVI is -to find. -the extreMum of S& d.e' by ChOosit19 Vf6pett to Y('Ji:') t s'

    ~
    To f,'{lct G-Co) ~d q,e.) (by e,li rvill"\ Cttl(19 S)
    - E:)(tr-eMl,\r'\ of S&d.\t' ~ (espe~t W Y(}t.')

    Gy = ctG- = I2'V/[(pl-tO')S'+'10<')lf(~~')(.)(1) - .ACU,).{,';\.(.) (2\)


    dV().(')

    - E><t'feM\,t(v'\ of JG-d.lt' "7 vespec+ +0 yC>t')

    G-y -::: ~ = 0
    d'l()(')

    G'f - G-~ - 0 ='> '


    ~

    . ~ v[(P+cl')S' + YC\t')J f(l.<j~) ==.).., q,c'it~"lt)7· ('2.'1..)


    I 'f
    , J rnme as (Ib)

    o • The. Bulev B"q,uGdion is- ClssociCttut V} J GcJ.K' ~ respect to Y()Il')

    - ExtreMlAM of SG-~)C.' ~/ respect to s'


    Gs ' ~ dG- ':: ~VT(p'+O')S'+YOt'~f'(\t:')()(po+d')
    Ob'
    Let W(Il.') =' ~e, sto.;\'e, COY1-\i~~'t:' Cl~iM, ... , ." '.'

    rrorVI' (lq) ~ .().()'(}., Jwut) d.~' bot/,t\. gicUS;


    Priet of "-Conn V\t tlaiM ~t 1; that pa'lDff W(~) at tTl = .

    T W().(.') ctt'>t~)(.) ,0..)(.' :=; \ Wl~') ~ t,t'(l;0 f()L~).t) cht.' (24)


    J J !A'bt.)

    {JOOloff FUt1c.h"o~ of (). ~U(e. C,\alYvl D1 1 (A nit of '1(}.l~+I)

    rq,()(~)()Ch('
    J
    -= (' ·~U'()(')
    J LA't)(.)
    t('>t:\A) o..)t' - .1-
    I<,t
    Cz~)
    bO

    2.') j- step -1t\1ea.d $to.te- Confit1l3eV"lt SecuvHi~


    ~ oei,vifl9 &tIl j- step- al1ead s-ta+e - COYlt1(J~eV\t ~ecuvihe..& pnUS

    c\s fuV1~+iOYlS. of. the, , 1~ S~ -aheact·stttte - COYlh(\~e(lt seclAri ~~

    state- v.
    "
    ),( =.

    -
    i(X.),bl) ,
    ~ ~+t:tte PtiU at -t VJileVl )):.' i $ -th'e smte v, -IVv' 1 ut1it
    t
    l'""li"7£"! ell,,,,
    ~ _ .
    ' -:::: f'yi'v~ m -lbVj-~tep -al1eoO.. C<J(\I1~~+ Cla)~'
    pt 'I.('·.,(t+')
    ttt t-l-j

    COYlSUiVlPVCmo fl. ().. Co ntin0eVlt C\Cl\fYl ~j ·ttr -tiMt -t


    !4AeVl ecOYlo'f>1'1 is; f1 Smf'e. )(,
    e -=..; v1In £V. weCt Hh

    o 1. t t+I 't-r2 t+~


    "--v--J ~
    J, q' ()(:~) 'Y'()(: leo) o)t
    1

    It'e. A, \/
    ~

    \/
    'V

    Vlold ot t+l
    b1

    .0 t;
    Mo.x ~o "i (0 ~ce~)
    ~o

    ~Lt Ct; + Pi;Sti-I + ~


    J~1
    r q,jL)tj,)(.)y.i(}tj~)(.) chtjf /
    J
    e

    ~lna Pt. ~ PC)4)

    Ct- :: C().Ct;)

    [P(~I) + d'] s '+ y'C)(:).() + j!. f~_1l)'{~ 'IN) yj(}(i1 )() C(,).t.i
    J=:z.

    iheVl , MUltiply C'l~) '0'/ q.1().{~){,)

    F< ',()te0~h(Jg ~ (eSpect to ).t'

    S[I~(\£').l-(f1 S'q:(~,~) cb<.'...;- J'1'()'c~).() t£<.~,)() d~ - J


    !~ ~., ()£i,~) ltC)(~~) yi()(.i.)() rJ..j rj.>t'
    .+ r
    e't'l1..') i<.~,i) cJ.)(' == 0
    ./

    c~ + [pelt) - f [P()(/)-l-d,'] .' l,fllt:¥-) cb,t'l S'


    \--- --....r ./. l r
    . .' A '" FOlndajVIrVi\'l:J. vOt IA
    /

    + !J t~(}l~)(.) - ) ~_1(lR.j,~'){~:Ot';)(:)d){1'1jLltj,1t}c;l}l
    I. ~ J
    \3
    e

    If A = 0 TVidividuM C't:AV) obt~·'V\ LtV1 bOUVlc(ecl COYlSUM ptiOVl)j, vvea.l tk


    B '= 0 (wn'de still SCdiSf'li~ fut l3u.et~tC0r7s~;v1+)

    c. + Sf)'Cll.') q,\lt;)(.) 0-).(.' ~ e


    -I .
    b2
    s\-!Glre- O-S lIZ;\"
    j
    we ~V\ choose s' -= 0() => C ,;:;: oC

    . ('Iou. VJt\.ve., <lnnnHe wecdtlA , cctv\ make ().. lot-of bene/H) .

    ,
    If A'>O -:;') we ean 6V100.u s= 0 (1his asset is: expt'Vls'IVe,)
    secl.'vitie-}
    ./
    If B <: 0 ...:'> we Uln c-l.1oose '1j(~~,~) ==~ foy j =2 .-:) c=oO
    If B '> () ~) V\ ,
    ic}{j}.(} -:: 0

    If A='O
    f\Jo 'Bu~~le IYl Avb~~

    ~ =' 0 1 .:::!;
    <
    o • A COVlVlot be, Vl~./ pas,
    ~
    G + S8'ot') t((.).(.',,\ot) cht' L e
    P()()
    == J[r(~'} ... d 'J q,'o<)() 0-).(.'
    ..:Je-. ~ ()(,~,)() :::. I q,j.\){~~) ic.V:,uJ rJ.:i
    1VliS hetppev1S <IYl tne lOYlg r-un.
    It ~1\Je.-S (). recurSIVe., wa({ of caleula:t7f1~ Pf)'ce Ot j-Pevi~d.eOYl-n~V1t
    e,la"M$ 0Yle£. 1-pev'loc;t 6~'IMS 'via-lie,.. be,eVl priced.
    "
    /AYbHm~ Asset - PviCit19 for.M'4\£lS .
    l<eBarclless of - pf efe\'l)r1CtS "then, o.S'~et price.s (V1u.st be"

    - tecnV'\o\o~y of Prtld Vl ~u.G~ tho..t ·tY1o.·IV<lcll,H:~X9S b~r set

    - .Jist" of' el'1ctowrVI€,v"lt YeMQ.·l~s bOlAndeo.. 'Wl equili~yjuM, .


    (§) MOdig\iani - ~,lleY TheMeM
    -"l ConSldevin9 ().. 2- Kirld,- Ot- tve.e versioYl of I.Mcaf,'s Modet

    ASSl). lYle.)
    ~) taCh kln6 of tf'ee '{ie-los et'lvideVlos CAcco'1f"f19 to fA rvtClvkOv' Prvcess.
    diA; ~ oivid.eYldS of -the 'i.;t h k"flcl of' tree. 1ft:: 1, Z
    i~) TotCN\ ~Ylvid.encls;

    dot ::. d 1t + d n
    );tot :; (0,1,,, Ott) = gta.te.. O't *'e. eC{)YlOM'1
    '\ 1
    2. (7I.Vl~ Yo.vi (;tWos c!ividtrld .,treaM
    , 6.. > 0 ~
    ~v) iSI- kind. of -\Yet-: l·,ves-tvV'el/e.-- i =-) throw off v"lOnne~Cttive felt!
    tOzti is gove((led by ~ 2,-£w.te,. Markov ftoass

    v) OivioleVlds w\<e e"1'\':hev \. 6 > 1 0


    Dr "
    62, -:::. 0

    '<6
    Wng-l2. UVl Case, ~

    1 >0<6,>0
    ~=o
    < 6,>0
    6z =-o

    6z ::: 0

    I·
    t+I t-t'l-
    /

    ( e\;=. 0 ')
    \J'~) Ov'lce d Lt C :::: . 0 -;;:.') the\.{ fe,iV\o.·l() zero fbYe.vev. -
    (The tree vws cliec1 8<. title. -Pi((Yl \r]etS bee-V1 'oCAflkV'uprecl).
    \Ji~) tdt! follows CA 2-$tQ.'I':e ~o.vk,?IICltlCt:,Vl ~ -tn;lVl$"itiOYl MCltnx :

    'h)j
    ?rol?
    .~
    i--"P ::.

    w"eie.,
    l Ro'\

    0 ~ P11
    (1-1.

    <. 1.
    P

    - Prob that t< living tree. wlll be alive, next period


    P,,-, =0 c\'4 i tU.v.ctr -t+I. dil/iw,(lcl a+ t
    \ .,(
    Pij ::::. Prob,tGt~,~ 6j \ d-t= 6.~
    b4

    At -Ii CVle- t : ~

    .. .
    '~
    ~

    '. . . • ~ • • >
    : ~ 01

    ~
    61:>D

    If ne ~e,ts 6,
    ''-':, 62. =0

    I I

    ~ (No Prob to <iJef' 6, )


    ff he. ~ets

    vi~~J let () -\Yet- ~ hieVl vlsk t;r/V1


    ~

    The-firm is~ue.s - looncts (i.e. Asset vy f1xecllout lowye-wrn)


    - €4,i"hes . (I.e, Asset of wv,o.t retlAyn£ deper1d.ect 0(\ -me fj(/YIS perro{~t1U)

    Let b -:: : limiT of ~oV1ds tho.t flirm ISSlAe--s

    rr
    \.
    I
    := cibt+j I =- fixed. rl~k-fYe.e ffite,
    ( C\ CO(]Stl;ivlr ·COtApM\ rz;re")
    ttuxt eQclA bond. po..y pey peviod

    ~x) A firM of t'lpe'2. (6:/. ~ 0) \ SSU~ bov1ol~ s.. eq,u.,ties 1 Wtlich (epre,seVYt pClckc<~e of
    \. state- tov1tiVl~ €V\t c-la'IWl.
    If 'fb f cit ..j ='> The fi(1Yl issLAe' b tv po.l./off r (per boncl pev pevioct)
    ~~~'fS'"
    { If (b > dt-tj ...:) b '" clt-ti '"
    o
    / (slnu. the. fir"" CiA n pO\l( 1'10 Mote. -\'h&lV\ dttj)

    If 'f't> < cit;t-j =-) 'Co - cfttj ~ 0 =) dt-tj -;, 0


    ~
    The diffevence Wn be pci,cl fur The equit'j of tYle bonOVlOldeV'.

    Eq,lAi+'1 po..,/S (Ottj - "0') pel'" peYlod.

    =::) v-b - Ot1-j >,. 0 ...;) clttj ~ 0


    ~
    £q,1A·11\.t pC\.~ s 0
    c4.j

    rb
    -} l2efurYI frOM 0.1\ e'tlAay
    peV' peYiod.
    I
    Jrb:et(ltt<,,)(.-t) d).(t.,
    'itt.,~A ~
    ~ -l

    } 'Ii t;t-\ bt~


    i(e,tUV'Y'l trotvl 0.\1 bol'lCl
    l'
    pel' peviod. holclfl,v
    0 1. pl;viOcl

    'Bl,t ~ lOTOJ vah,t.e of ~~~ 1"'110.. of. B(m 'S bOVlo.g o.t time. t, \i~::: 1,2

    ~~ :: 8,t + 3~t ==- Toml va[lItL of boVlots

    C,C;1ftll~n-t 0lo..l'M

    Vo..lu.e of bOVlci depeYlolS 011 ~J


    ~

    Le+ S~t := Toto.\ vo.lu.e of ~11Il ki(lct. of firM'S eq,llltie,S/o.t tiMe t.,
    St : S,t~S~t

    ~
    /
    S2.t = ~ \ (c;(zt+. - rb) qi( 'l-tlrt-j , ),(04;) c;I. }.(t-t-j
    J"" J
    Y!:><:d.tii

    6~ =0

    4'h"

    Bzt + Szt - ~,J °2t.. ~(~t-t1, )it) d~ttj


    1 - 0
    o
    Tota.\ Vo.,lu.e. of 130Vlds ~

    S~ ": ~I I V'b q!()(~,)'{~)Ch<tTj + J~ ~ dttj ,t()(1>rJ,,>Ct,) chtt;.rj "'~ . (~o)


    Yb ~ Glw-j '" )(' rb >d...j '" >t'

    \ot~\ VallAe. of ~q.lAitie.~ :

    So\; -== ~ ~ COttj - V"b) q,S<')(t...j , )(t) chct...j


    y\'} -'dttj ~)('

    Toto-\ Value of' tlfY\'1·

    Gt.tj ~X:

    I3 t + St - ~ r 01;tj q.j(~j.),{t) cJ)'(to-j


    J'" J
    D

    o • The. \/C\lu€,. of -ltle fi ((V') ctepeY1et~o n dt-tj. g,. ~t (.).{t-tj , )lot)


    ~

    do'
    = Jfcs,d)ds
    o
    ).t'

    J
    J et~(~t-+-j ,~) ct~...j
    o

    ~'. 1Vl e, toY1d.H10YlO"\ e."pec+o.no fl '1V1 C'b'2-\ 1\'le obieC,hve. fY'l of tVJe hoY!,
    IS \fIJel\ d.efined. "/ (espect to tYle o.'oove. I(?}.V\SH10V\ ?rob.

    ~C) We- U,VlOvJ tIile. \aw of tv\OtiOVl of the pYice Df· Bf(¥), ?-\;,
    (S\oe.< ~. = \-lca.) " ',. c, )

    ~ we, KIIlOW iVle o'oove, TtlilV1s·,noVl Prob.


    e-y.. .If r'o < 64 -;;;') ll1e fi((Yj '\\;WeS 0. ~rVlCllleV'" €YlOU.0h '# OOVlds
    &.
    sets ()I. SlVla\\ eYlOU0Vl COUpOVl t,
    ~
    'f .
    to eV\O.\?Ie. +0 po..V -the ?rt?l'\1i~ed Inrerest o.s lOVlg t::\S -rhe tyee is' a live

    ® Govt J,. Rieav'(ji{,\Y) ProposHiOt'l


    AsSIAMe.,
    -1I} The. taovt isslAe-s 1- Peviocl cI~\ot thoJ is ~mte toYltiVlqeVlt.
    (Tht ~ovt ~I\\ ouiotL whethev ~el\S bot1ols / iMposes mx€s) .
    CO cit (~ 0',veVl '0'/ Gt fv1aVKo\l Prvcess \J'f TffiVlSi\10t'1 DeVlr,ty: f(~-t't-"d-l»

    ~~~) G-t &. o.t ()..Ye jo"lV'ltl'l oescvibed. b'i 0. Mav\.<.Ov PQ1ce,r vy TmVlsrnOYl DeVlsity:
    V\ (GlH-1 ~ ~ \ Gt , cit)
    d'G' }
    I) h
    o 0
    (1.,5; G-,d) dsd~

    \'v) ).4 -:::: (&1;,dt) """ tVie I?mt¢ ot t~e €COVlOM'f


    ~II'
    2 roViOOM \lClfiabet.·~ (1i\1 kilows itJis Tmt1sthOYlDeVl{ilv( Fn)

    v) G-t <. ctt vt


    v'~) Gt is thrvWVl o..wo.'1~ ~iV\1Ud no lAtility"lv pAvate. ~eV1ts P
    G-ovt finances in- el\peVldihAve.s b'l G\ &'treClrYI of ll.{MP-~lA/V1 pev capitCA -roxes
    L___
    G~ ~ !t l--l- ~ .:- v
    ~"...,J (2t;
    t

    WMp-swYI,ft;tjC.

    ~ G-t ~ =. 0. non net:!t:thve. ~tvchClStic. prvcess


    t1tl :: 0-. stvcrQ~hc PflIcess ~ 4 ::: (;~(){t)
    fClMt- (J~ <1;... i) -aODCts t\tIat tW. 130vt 9'rOMI5«.S Ol {, 'tv cmlivev 1
    Let IoC).(tT,) -= o.Mt of \?ond. ;-nClt govt isslAe at tiMe t+1 itJIleVl tVle eCOflO(V1Y
    is \() stu"€, ),{t;+\ C60vt sell (;oVlds to people..)
    '0 (){t-) = De'ot "I'V1o.t qOllt \t1O,~ 1-0 pa~ wck \n terM ot 'ooYld~

    1().(tii-1, )(t) -= (!,\Ay'l'eVlt pv1ce of 1-Pevlod.-o.\t1eact goods Gtt t pflivloled >4-1-1


    1

    Govt's a~e.t eor1S'h1iWlt :


    [G' = ,,+ J'i'>4-,,"') 'at"..,)"!>,,,,
    , ~,.
    -
    .
    \:>tl<,)
    .
    •
    '. •
    ;~
    4
    1
    <',. ~ .
    , ..
    If t\rle v{ebt is Ylsk free' =') lla(~I) :: b1;~'], -ThRVl
    Gt -;: "lot + bt-t, ~ q,(\(t'+I~ ~i;") ol~t"', - Vt
    ~t :: 4 +~- Ot]
    ~ Bond- fulAt govt iS~lJe£ IS' a peffe"tiy SLtf€, cACI;(V'J WtIen ~ c(.e,0t IS v\s\.<. tret,....
    ~
    j C("(,).{t-+,, ~t') Ol).(t'-I-, - 1
    fZ:'t
    ~

    ThIS tells V10W1Y\ULV\ \()cf,v',olucJ will 'alAI.( bOVlets C{YOM ~ovt) depends OVI q,
    ~ £qUfA.hon l~,+) is 0. 8W.VletQ~ WirYl of the govt-'s aCt-mole\' ce(+o.',nty.
    ~(Q~el1~ v"I,tX.. 0~ ,tW-r\<e£jM of Govr ~1f1Lt6 '
    n-olV1 (~'?1) : ~vl;&b\£\;\t __ ,~ ~
    ~
    ""
    '0 ().t'-t) =.
    ,/
    I t l)4) - Gt{,'l-Ci;) + 2:.
    5::\
    5[t laS
    Q
    ()(.t+j ) - Gt<a ()(t.-j)l q} (~i>+j,).4) cl }(e.j
    o(l

    W'lMe. b()(-t.<i) -= t-\ [1t.j()(t.i'j) ~ &~().(t>+j)l .


    " "-r --
    {v.hMe.- 't'Clx 'SurpluS

    ivlL$ ~lAC\-\'l0Y1 yep(€SeVlts ~ \Vie- BlAd.~~t CoYlStal"t\t ~ Govt spe~clll\/j~'


    rf \-lH o.ntitipatt<t. ~o"t C.ClV\~ot po.y bo.cv- fbv 'oOVletS, t\.1{''( IM\I (jDt bu.l( bCWld-S
    '~

    ! '> G ~) S'uvpLu-s ..
    1"ltle SocioJ Plarlt1in
    MaX" Eo ~t lA(C t )

    s,t. Ct 6 Ot--qt
    ~

    1vL.t solut)Ot1 ir r e~ := dt - 9t I = Xt-


    -v"
    .1Vt€, eq,lAi\ihvlWVl g-mte.-CoYlhn~ev1't Pv1us aye:·

    ~ (\(t+ l , ~t) - ~ LA ICc\.t+\ - «1t->-I) h. ~tt-l' I


    qtt-I d t ; ~~
    V\.'Cdt-(h) . t
    COMpMe-tv (leI)

    ~J Et ().'(ctt+l,gt.>l) L%)
    v.' (d t , (h) f
    U'Mplue to eEl)

    «icardiaV' Propositiot'\ :.~ . ~


    c~ ~

    1) in e. €-q.li,\i ioYilA M C'.OV1SUM ph'OVl g-IYetlM &. state- contit}~eVlt pnc..e.S

    .~peVlo. only OVI tYle. stvcV1t{,dic process fbv' output d t ;.. qt


    ... 1-
    C-'" q, .
    Q) COV1SUMphoY\ g. State. -CoYJh'fl¥Vl+ Pdcu QVe, \?otltl iY1ct~peVlcUVlt of
    #1e ~tvcltla.stlc process fO( -m.xes tt
    /

    3; The. cI.t\oice.~ of t'tt~:o ~d lbtC~o no..ve V10 e-ffec.t OY"\ o,VlV r-elevttnt

    e~v:\tibv1lAM pYl'Ct / q,u.aVlhty.

    C:;;. \rtClve 1'10 eH:ecr OYl peop-Ci's CoftSUJV1\Otl'DY\ eli (usuM£d +0 Uvefbl'eve()
    ~

    1Vle prQ.seV\t \Jcdue of ~e <;jovt is ·ll'letepe~oLe.vtt of' -H1e 00vt 's -fiY1~lIIc.ji'l9
    eteCii.>\OY\ Cwnetltlev' govt fi naVlc-es de~'c.its / S'uyplu~) .
    :to

    1\-) fro(Yl C'b6), the agent" o.CClMYllAlC\fe bOY1ets:~.e)(pec.t +O.lise.tt.1elV'l ttJ pai.{off"
    -tY1e, vevLj -PlAt\)Y'e. to.xeS .

    If Lt ~ Gt 'r/t ~) \? (,).(t) -:: 0

    If 't", > Got; vt -:;) \o().(t) '> 0


    eH~: @-iCo.v'OilU\ Eqpiva\eYlce
    .. @ ~OVYOwil\.~ £'iMits
    sw" .
    ~ f<icoyclioV\ tells tV1~t 1tJe tiMiY19 of IUrVlP" t-axes o.oe~ not M~tteV",

    ~ 1VCV-S on how fkL timiv19 !Df wxes inte(t{cts vy,. (f'stYictiong on tVl e etbilify of
    HHs to \?ot'Yow.

    AssuMptions :
    .1) IV1te(est mte IS e)(00eVlOUSI~ glveVl.

    1) HHs \oOVVOlill lAp tv COp'ltcdizecl vetlue of t\rIe eVlcJowMeVlt ~eetuence~.

    ~ I

    12etlec.ti~ -tv fkt Q\leYlappi 119 - (;.eYlemi1OIlS Mooltt (IVlhn de t-toviz.e;fl MO~)

    ~ VlO borrovviY1~ COYl~tr-CtiV\t =:=) beq,uestq, >/ D

    ACCO(eti~ tv Ovevlappi~ (J-enemtr"OV1<J. (\IIoote,l, ~icorctiaV\. qrv£'M()fe. OS~{)MphoY1 ;

    . .:. 1ht '1f)t1n'lte hovi-zorl MOcltl i~ Yestnctecl. LAVlcle( +i1...t notlAm( bOVVO/IViY1~ liMit.

    @ TVlfit'\ite l'f ~ived - AgeV\t ecc'llofllty


    A) A.S·S~MpnoV\s
    1; An eco'!1OMY COVlsists of N icUnticcU HH s ,

    2; Utili-h-j FuVlCfioYl is 0. stn'ctll.( incveoSiY19> stvictll.( c.onccw£,.7 (.,(.'(.) > 0


    U
    .twiCL-differeVltiob1e cme-pe0ocl utilih( fn. U (.) L D

    rVlo.~a eo.,d,iHOYl: D~:LAI(C) = -1-00 1

    3) 1lr)f've if: no uncertainty.

    1<>1 HH can invest ;Vl 0. s"(J9'e visk-fy-ee asset beCn,;f/g


    0.. fixed. glOss one- pev70c{ mte of' re~Y-V1

    (The osret i~ eitVJey 0. viSk--fr-<Z.-e IOtlVl to \' wve'i}ne v


    Govt.
    4-) B~ t ee"stmi JIlt
    [C.., + ~-1 b't1i L Yt + bt.l
    Wit.cz'l'e bo is; giveVl
    ?) et .., :: Ct
    ~ bl,-t,> 0

    00 (
    ..... \

    HH ('tin leVld. blAt not bOffOW

    Co..se- 2) HH CDn bovyow T blAt onllf Cln Of\1ount tV1Ar-l+ if; fea~ilole. iv. repo.y_
    ~

    \:Iv <;;etti n5 c-t =0 \It


    \/
    v c/IJco(.(l1t vOIUf of gfr<?tln, .fi< .
    .A IVlcC'/Vl..(. ·lure,
    00
    (~/(reH _
    bt -= -2 -J
    R IJt+J' Il'l( InCCmt) (~,'3)
    J"'O
    ~

    lAMue b '" notu..M clebt lif"l i t


    ::;0. liMit k>Dn-oiIVf~.
    ,-
    eVGV\ C t -=- 0 =OJ tOYlfUfYley- CClYIY10t (QPQ~ (Vlove tVlClVI· ~t-
    •

    (2.5)

    ~
    ~t -? be- I i5 eV;()le,Vltll.( weal-<ev 1'VlCtVl ~t ~ Of
    Notl)- To rule OlAt "PoY1~i ConcLinoVl" by iYvJpOSitl-~ iVC:

    D.c;, R- ~ 1
    T
    b"r 0 (Vf-)

    £,) ~ol().tion -to ~VlGlAMptioV\1 SGtlA~S . 'Dec-tsioY\


    oc
    Mo.x: L ~tl)..(Ct).·
    , .. 1;-0
    let, btto} -
    too ((!w((\

    i'
    s,;t, Ct + r<-1 bt+1 ~ Yt + bt.
    ~ \o~

    F.O,C UIC Cf;) = A


    A = .~ r<.. A.ttl
    \/
    V

    llCC,) = ~R U'CCf;.f)

    ~
    ginu..
    t
    ~(l. ;

    bt +,> 0
    1
    ( ~) (Yt+bt ::=. £;,) = C't+1

    ~
    fbI< =- 1
    ...:') (Vt;-+-Ot '= C.t,) <- Ct '!",
    bt-t, ::: 0
    y
    '. ,}.

    Y~

    ,......,.-I-~-7-~~~- t
    AtsWVl.(../ b0 ~ 0
    Y.J.

    Cq"~VlV\.l,, -It,lc, I.\Mt; b_ 1


    P(eJQ,Vl-t vo.lw.
    .{;
    PV f3lAd.~t (pv of HH's eVlclowiVIeVlt) ~
    -1 . -2. -3 -If" -5'
    - Yh. + R ~..( + I<. Ih. + r<. lj.( + f< Yt., + r< Y.t +...
    ~DV
    z. 2. :3 q. :5
    Co + ~ C1 + (b C, + . Yh + (by,! +(3 Id J,... + (J; fj..(+' (b y~ +- (b If,! +..•
    C [1 + ~ + ~z+ ] (ljh +@ (h") [1 + (b~ + ~JI- T ••• 1
    -
    C ~h- -+- ~ Y"t
    1-{O 1- ~3.

    .". ihe.- sotutioVl +v l-fH's optiMizatlOYl prOblBM (~

    COYlSmV\t ~rl~il\,MptiOY\ gtye.t/1'\I1 Ci; "" C 'iff ~ 0

    FroM (2..2) Ct + 1<-1 bt'tl = 'it +@O


    ~

    b-t-t-\ ':
    lfh - Y.l
    1+ f>
    ~

    bH1 ::. 0
    I'r'i.suw../ bl) :::; 0

    !Jh- '> lJ.( '> ()


    -+---+------f>.-t-
    o 1.

    'fht b'olunO'/l ,'s- Co = y.{ ==) b1 = 0

    WI1/ -h-oM pe.nO~ iO'nwa~, fkt. rotuHon is itu. gO lV1 e 45 Iv, e;£.. L

    Q '. 1ht eOYl~lANler is QO(yDwi~ eOY1swlflec( -/tu... 1 S+ per"ioc/..


    c) GoveYnf\'1ent

    I r6-t; + qt = !t + 1<-1 Gt-+IJ C3.1)


    Wtttye, qt ·ftnCll'lCtet by It
    •
    10 ~:o
    t = lj0lrt purc""a~$ tt siYeCtr"'l pe.v rHH. •
    lrt~oC ~ 0<. S'treaM Df iUfV1p-SUCVI m.xes On H/-t
    f-t=.o

    et; 7::£<Y1e-peviool debt- clue at t

    A~UMptiOV\$ :

    1 &ovt ecm bOI'VOlN;7 ItMt cannot bo(Y'Ow indtf!fli+e-kt

    CL) I-tH ca~VlDt bar-vow

    11m \<.-1 B _ 0 -- -rve- -::::) rule. OUT POVl~i sc-he~.s.


    T?oo

    G-ovt's 0~t eon~tm.' n. t

    \ g. ~ t g-j (Iv; - g"j) ] (-S.2)


    eff~t en HH

    +1<.
    -1 bt-t-,

    IVC :

    'Ve-f: G-iYeVl Cb gil)


    q,

    Eq,lAi li Iwi LtM


    HH plaVl5

    GCtch 'I1tIlAta) (101lt pOII'clf ~·atis-R·~s iff but~teo~stmiVlt (1,1)

    b) G-iVtVl Ltt l:o' iht. HH's plaV1 is opfj{Vtwt.

    PropoSinoV\ 1 : Let bt pfevlAi \ s


    C1,0) '3.>0) ts 9"ve.V\;
    lC t , btTI f: o
    & be ~ >1 eq,ui I; b-ivrvr

    ~
    ~Ct, bt..}oC
    St",o
    ONtet t g.p it, 3 t ..}
    f
    ~s al.w an €quilibY/utvl tNL1e-V"e,

    b" t .z- R-J (Ct..-j


    = J=O
    0(1
    -
    •
    '"
    + Lt...j - .'1t ...j
    ) I (~;:t" )
    & Il 00

    got ::=.
    f;o I< -J",
    (It ...j -
    -
    9t-t,) C~/8' )
    /

    Prvof HH ha-s rlu.. !lOMe. e-oflSUlVlphOYl plC/Vl ~' Ct L,:o


    bAt adjusted.. bO'Y"vowi~ pletn 1b-t.. , t=-o
    ~

    /\
    <;olve. I-tH's opti rvlUiVI pmlole{ll\ due tz, .6 'lot
    \/
    v

    UV1clev b t
    , HH -h;t(.t.s tt 41Yl9[t intevtBMporcJ. bvt~+ CQVlS'1Y'Jtjf'lt (~.4')

    At t"" 0.1 HH wl\ CltlDo~ t\,Vl opti(VIcJ. c..ons('(("1ptioY\ pltlv\ $'u'oj eGt- to
    00 ""

    Po -= ~ IZ- t (eil - Yi;) -+ ~ It'"lt;


    t=-o t=o

    ~
    HH'S W1t get t its OptiMet.t plaV\ does Ylot olepel'let 0Yl 'fW.; 11Min9

    o.f wxeS', OYllt( #lei.... preseV\t value..


    ~
    -:::,> HWs Intev-teMp0rAA ~t set UVla.lt~ ....eet ~) Y\ot"~ffec.+
    if Its optl(l1~
    \-ft1~ gitJi-:f:t-S ltlX'es Cl.WCJ..t{ f{-Of'vl ~ h.t:l'ur.e. ,tvwt<rol tW. preJel'l\", CoYIsvMph'oY' pltilt'"l

    A \ars-e~eYlOW} lA. t1 t,.vi11 CUlif1ii-eJ-l( eV!~we.. tU'l.-t 90vt ,'s (.( lenoU(,~
    f2,u;t- f:1'rtb. B"H L'aVltlO'\- be I'vuit bred =) qD It/; (Vt(,(.st- r~ ab rt7tJ< of
    C"f11i'r ~k>w tLu-.f- t<.t'c~rr:>lit/rvl Gq"ilvolewt 6"ea~ ~

    -1 -1 - -1 -
    \-tH : ei" + R Chi = 'It-. + l< Y.,t - L:-t - I< It-tl
    1
    C :::: _1_ ["Jk + r.z-l y.,t - (ft + t<- l.c1-1)]
    1+(b

    .
    ~,

    , ,/

    gi; + \<-1
    tft + 1
    ::: !t'" -+ R-',~~~' 9
    -B G1 ~). /tDt
    c, -::: 1 Yh + r£\/..t. - ( 91; + 1<-1 gt+) tMr
    1-f-(b
    If -) tit
    - -1-
    ~
    kt-t ,
    = CJe + r< 9-t-t,
    /

    P~pDsi+ion Q :

    Consider'" ttVt 'Inltia). eq,lAi li loYi,UrVI, vy

    b bTl > 0 \1 t'~ 0

    l,e,t l Zt t:o \at -ttu. tttx rnte of +W. rni11a1 e<tu7li)erY'~:

    l ~t 1: be- ttv\y Dt~e\" +tt><- mte,... b'eq,uen U- tOY t".M1'c,,1A.

    io
    0

    bt :0 R-
    j
    l C-t-tj + i t +j - lJt,+j ') .~ 0 Vt ~ 0

    -0
    fW-V1 J

    0) linked. Genem.tionS IVtteV'pretatiovt


    One- Pevio(j-Lived. A~ts' :
    ~ Aqt-Vlt valULS' eOY1sWVlpil'cYl & utilllt0f hiS divect ctescev1tx.eV\t~

    f..:" L/oUVl9 at- t+ I

    ~ 'Pre fere r1 C£.q of 'loUrtB pers-on aT t" :


    lucc,l = Il v Cb<..) I
    4 be-ques+-
    tflA€(t lACe) IS +W- S(l(Vle uti lin., fYJ as In -re.u.. prev1o,:,($ sech'oy/

    btTI ~ 0 r- beque.rt .f}OM -tifVlL t to t+ I

    V U;/~"'I) ==-- -ti-u. MCtX Ldi ('1 at t+1

    Hal<' V ( b-t')
    °t, b tT ,

    ~,t + r<- bt +1 ~
    l
    Ct 1:1." - l t + bt
    bt-l-, >,.. 0

    o 0 A per30V1 ea(eS about hiS c;l.ifeC+ deSC€Vlcl.enf -; bUT Ilot viC£ versa.,
    /

    fVufe, i~ an rn-h'rliteJy lived govt '."


    - 00I.,t

    ~r'(lLQ. VtD' ~orY'Dwi4 W"'J-Mtl",t

    ~.

    e~q,(,tes t"g pla~ *tL mle. of' go..vi~ S bt-t-'


    ~

    A pt>s'diVe. ~avi!1j~ CeYldltiOYl bi + I > 0 becofVIe-s OV'l "'opemroncJ' beq,cAe.st MDfJl£ll i

    In tW. Dvedc<pPi~ 6enemfiOYlg- (vt()(ut

    JJ
    (e,.fle£i+ RiCafctiCtv\' eq,lAivaleV\u- Pf'opoSifiOYl 2.,
    (new to-x po1iClf Must not be. so d.lffev'eVlt trofY1 t\t1e- ',n"ltittt One t!1Clt
    ~tJ'
    H (eV1cLe~ tVu. 'o€q,lU'llt fVIonv£. ~lflope(Z;(,t1ve....)

    ~~I>.\L s().J~

    \}i} ~ '-. '""~.


    y-t-cd·
    1 1 .

    ------J:,
    ()z. ., Ldz. - 1.-2 + 122) - 1h,e. 2'"10( ptVl'cd 'BvdJ..et c?oYISa-...."Itrl-
    Cz ~ Yz.-"t z + t<.(y,-Z1- C1)

    C1 .,. C-z.
    1f
    :. ~ -to ~_ (1: 1
    ~ \:
    -T k]
    R.
    JYlclivlMcJ.:s IVltevt€fl/lporvJ

    f?V of HH's
    HHI& Aft€v-w-x -\-(}..lC 0l:1rl5o.fun
    we~\ittl. 'to 'tW ~ovt

    g-/

    ~
    ,/

    ...

    (;vv\-;

    =) ~CMA<~G'''-'11l- q1 -:) 8u~t ru(plu~

    ..;.) ~':'~@I== £31- Z1 .,.:.) ~~t 'Deficit,


    Gvvt bonds 'lVlc,t rvt~I~'r be iSsued. W couef sV10rt 'fit 1/ inffix :reveYlue..

    Tn tftu- 2n rJ. pM'Oo. ;


    ~ ~ovt Mit-Sf get tilt 5 at ttu.- lBUe.t ~t Cove,y lootiA q~ ,f... ~b

    q:z. + 12l.? ~ tz
    92. + R(91 -"t,) :. l1.
    0z. + 12ql ! 12 11 ::: l2.
    1Vu. Gov t /.s xVlter't-e M pOY"cJ.
    !3uCo/-r Cevzs tit<-, V1 t.
    PV of"k;t)( gifeu""
    ~
    Bovt'S we41~

    ~ 1111 ~ Con~tr7AIf\t does not )(YI plLt fuctf tW ~ovt Muct balan u itg i f:w;l~-r

    0Yl (). pono~- b\f- pen'od. baSi$ (i1I'f£w~~) ·111/$ i s eevtal'1l~ fea5"'ble.;,
    ~ 0l.tt ,f +Cu ~ovtwaV1t tv :rUVl Ct cU-fiCit -;:;) Vtave.. to \'1.(11 at surpluS in 'ttu. future
    00( planOfl cUbt obI !ga+Ji7rJ i b

    ~lcQ.~iQ.v'\ E:4,1,('~ VG\leVlc£ :

    1; le-t eta,) gz.) -Rxe.d..


    If Do Z1 .t. 0 ~)

    f
    -tetl< w.t

    ....:) ~IS pol~ \,r/11l haue. 110 €ffec,,+ 0r1


    o.~greBa."e. (J(JYlJ(j(VIel' ~
    Sj I\'"-_ S :: b
    --------#'~ b "" ~ iYLe-<- . Ll rp ~ - /J,f.. = C[!
    HH- Me- (r<ill,"1 .\-0 fVlvd/4J.e Vlf?NJ l?C¥la ~ 'rJ
    1€i.W1'n.. mc;/reol ."ah'oYlevt (j({vfr1 lm6h(!I~d,
    . -'1 \/
    '-Y
    t;J;tel'\ ftte-se bOVlctS flltt?:Mre,. In tf,...e. N-ture, HH he<~ ttl pal( off ~ V1f'tjLwr'
    'fa)( I?i II.

    • .,-, (Vlj~ o~ +axes d.o not Mattev' ~

    ... Gov\- bOV1cL~ repY€"-S0V"t ~S 0.. -R-ttu.re,. +tAx 0 b Ii ~a 110Yl.

    ASSWVlph'0Yl5
    1) Hl-l9 cue ¥t£.. +0 SMe, &. ~(OVII Ott tCu- Mayuf rnt m-re,. =) peffevt t1\tltl.VlU tvlkt
    ·2) HHs ave Ylot O-lIb~ to ~ In d.t-bt. ~'). HHs ave VJOt cU-bt-(XvlSfri::f,''t1ect
    '6) Hl-k (J.( e @tiOV1cvl
    L-f) tMMp ~u(V\
    +o.;xes ~) nor Oflll.f ct,s+orohlMt?o-l -Ia.)(€'~
    5) lorJ9-liIJtcl HI-t.=) . t-tW.s Plat1V1~ Hoviz,OVl
    & Govt's Pld nn h"1 L-+til1z,oV1.
    \1~f q. f =) 4''\,U ~, ~ l1 ~) ~ S, =') ~.+ ~) 1
    CH h, ...MQ(le!ttt\lf 1YI~9~eS of rV1f'latlo~ -
    (] ~Ofletn'Lf Policies I ' ,

    ~ focus on Ft of, M>ne ~\


    ~ JV) ~ ?iXitJ we, could use, bonk v10-re to tM\.( GolcL frO/Yl the FecJ.e~ f3CtY1k,

    N;sUfVle, 1; So..c;,1A. lX~eVl+- ViaS eVlctOlt'ilVleV\t = A


    [No teC"lI1v\o\00'f Ctt ~ be-giYlniVl~)

    2) A~ev1t hCl~ access tv +W +-~V1ol0VLf next peYiod.

    A,
    I
    o 1
    l'
    ·,nlHcJ,. old.. end.ow lyM'V\t' v.y A

    Ut11~: \.A2.0
    1'\
    olctfll'ne

    Al.lto.fk.'[ Eq,U:~\i\oYiL.lfV\" - '1 perfecr Co)'V\pehhc,rV\ (\,~,\\U.I


    _.- ~ eve"1oYle I"f"ves 0Yl 1+leiY" ow Y1 -==>. tJo troJJ..t J
    '\'~;:Y Ce0Yl.\<.\.M..l. oYll'1 tW.\Y 01''1'\1 !Wl{lb\",,..fV-V\+) ':::-) l'{aul- tA (A,') -+ ()..CA z )

    ~e,
    Gen~h()Y\ 0 1 2 3 ~
    ,~.{l5"'l

    "
    -~

    1 /
    /
    /
    7:.
    A
    //

    ~ 0
    •. //
    ,: ,
    ;..----
    . - OU-Y

    Vlow tv
    'I-

    , .,{Jy
    "
    In',01e&'t IS
    !AilOiAfe ()V.(

    vJeA'\b(~

    o
    re-SOlA,(;L'>

    (V,\Yf,z,'W<'1 lA"'A
    ,J.-o 11A

    1- A 0 t;:K c.VtCL"}"_ econ 0 J\~ '1


    - . --
    /,l?v\~
    -') ~tlck of Double &iflcidtnc..e of Wantl
    1-tM.e diffefeVl..t lA.!tJeV\..
    Wl{ lfIetlAt to fvfAcU. to -tW.
    otttlJ.[J'
    Let. Nt =: (1-1" Y\) Nt-I - POPtAlc\'\ioV1Gniwi1rY (;quCtJJZNl

    \}..t == kC1 t + ~C:zt+l - w~- U-n \;~ W/c;D'i£COIM'\h~

    A "" c-1t + S
    U
    "
    A+AX = c,z.t+\
    G) A (H}t) - Czt-t\

    A == Cztt!
    (1-+~)

    II
    v

    {V1().)( u. '=' . ~ C1t + kC2.t-t,


    <S, t. C-1t + Czt+1 A
    (1+~)

    FOC: i - )"-r
    C1t

    ..1- - ~
    CZt+1 1-t- :l,(.

    !VI l2-S ; eZt'n -= (1+){)


    C1 t
    J.A
    Z
    C:z1;-t1 (1-t);l..) C1 t
    t
    :. YDl).n~ V'/ll\ be allocated- b.[ -this ar"lll
    C1 t ~.
    1-+ }() etluiA

    4£ib,s.n.Ju-\e, tv g c: l':"'i

    tit + C1t :::: A . C1tt'l + Czw


    (1-\-")(.) (14->l)
    - A
    C1t := j.A
    '].. \ ~H'
    ::: i (1+1-t) A
    ~
    Nj, Cit + Nt._1 ezt
    .!>Ii, C1t" +(N:;', CZ-t
    )Y\; Nt/,/
    q

    , c'1t -t (1 \ C2.t"
    t:j:t",j
    -= A
    ~oc(&J. P\t\~~\ ~ \}

    ~,t.
    -:=- 1+V\ > 1 > (,t/CA,J
    t t)iCA;,J

    i<,.-" feW)'r is' ""i;rreY-1(IVl


    pe<fw" ?iJyvll'c,tin'"1l (\'J[,.j,u r·
    Foe; 1- '= A
    c,t

    .1- '=- .A
    Cz-t 1-t-Vl

    c.t =

    =) 1- CHVl) A
    2.

    'if allocate, to olel Ol,ll. elf' V1 <.. ),() ?

    / ~ A +0 'fO~~
    ~) o-lloCttte.
    ~ , .1 A' Not
    VOll"~rOp
    cb.t G-ovt) ..;,
    -:;;: --b otoC
    2o·
    <;,~o fIls good 'If &ovtpiay qolY\J- role. o~
    =-- Nt-tl
    ~olcl pop
    o.~\Dc.o.h'OYl ~(\ 1VI1l: c.aJA .
    -1 1:. /
    o iA
    IT/,=7,-+-=---f-----:.:.......j
    1
    /~ A s,'</'o
    2 / /
    1I \1

    :J.A
    2

    C2t tl = (v1tt-1
    Pt +,

    Mo-x v. = ~C.1t -+ At Czttl

    \ ~:t, C1t + M~I


    Pt
    ' = A

    ~oc : 1- A
    c1t
    f\I112.S; CZttl = Pob
    C1 t- PHI
    1
    C~t·tI
    -= /\
    ~;:)
    If C1 t - ~A
    -;) ezt t, ~
    ~(ji ")A
    P",-tl

    -; ...'f: c

    C2.
    ~)A

    ~~JA
    2...'
    - -

    A c1
    , CMcme'-f)
    :It Exc#lon-y. fbua~+ e(J(1Sm<lV.t
    ~
    l(eopU waYlt -tv e><c ltlClr1 ¥,

    if Eycltla"Y- ~(., '<.. 410~ ~G -:::-) p~ VI{).V1t to gtvr-~to Y'le x"t' C,

    r-f t\(chclI'¥ f6C == gW(~ Be, ==) <Ind(ffe{en~

    ::: 1 + V\.

    No~
    ,qoocls (\V~ :1Oi'
    IJWV't\ r,--IL,
    l>". Oefla-h'GY\ \'$ ~ood. In thiS Moettt r;
    MOM<~ \mFues \;J0l~Ye,.

    :\0 (CiOctLl0-
    '3coct: for C1'Y\~C~'yriO'Vl
    :J;
    -1 ~
    M
    0l-
    J
    I
    fec<SOn
    .1W.'1I MGU- \'0J.JV1 D A D
    / \UtI" vt.lt-k .. Mt
    tv( rv"("(\~'i
    w I I).VlhL.
    1 A 0
    , ,~

    'lhI S GeM \; of (V,un {~ 2-


    .v
    A 0
    (
    ~.;I\ \?2 a\li.J['.CLtecl/i)1,.L
    fir" (t-d

    rOver Lo.ppi!\i) C~Y1e<1',h(iVt$ Moe-u..l,


    \1cf1~) , A'r Oc ·h~ (;tlffele;~t- peliocl ecnW£\l1€y"~ n(,{ve- C\.1ttYl C£ Tv 1YUc:l-c
    ,Q, ~ '; ~Q -££
    o
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    \ ' ,
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    .u-.' LD n ' J1-e,7 1. -,a, n I,
    TV • . ~0'e)ey\lo{hVe.."O"'vtl IvtDC,(~.J,.._

    WD prvd:' in ·itiS fv'oJ..•.J" -=::-") l'WrlZ'([i€: onl.~ ,ta{d~ f ~?)cGvt(/,~ i2{(JY1b{Vll1


    ® ghoppl()~ -riMe- MqckJ.
    ASSUlYl£J 1) The(e, ,S VlO uncevm',n+y.. \
    2) f! + t = ~ . HH ~ 11"e eo"&-t".i~t
    '-1 ?'> ...
    gl1opp~·"\1n...e
    ?~
    Leisure, ·HM-t .1 unit (/fh~·
    •

    oc
    4-) HH's Uti\1-h.f : 2(3t.- lA CC-t;, .lot)
    t;;='o

    (j(cc, 1).0 <. 0


    'lAc...t ~ 0

    / yeaJ t\AOY1elfBaloll'1E,..e. . ",.J cllct\~lnet\ -\W-. Gt1 ot ("\lJ"Yl,,-,-(


    +\11,<;\- iM-\"
    \I'll!- \{'ICl f\\J
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    of (t uni1' IJ f i"~1V1
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    p' p
    ~ O.
    ~ -It
    ,Kc-/; + ~ = £-:.l
    ~ f\\ ~
    fa'/' .fl.t.Iu,(t..CU1ISVf"lP~on

    oQ t
    Mo-x 2. ~ I"l (c t , .it)
    t=o
    q,t, .l~ + St :::: 1. - 1lML eon~traKt

    - ew;L~-t ~strz;t""t

    fr}.Il€v~ f'I1t+I:::- nOMI(\cJ. bcdot1tL he-leL b/Lol -tr1VlL t J.. -t-+/

    Pt- ;::. Pti e..t Ieve)..


    bt ::;. feoJ, valu,e of 1- period govt ~onot holos ~a.t Mature at
    ~ be~ iy"\'1 f1tj of h'Me.. t.
    l~ -:: lU/1I1p-SUrvl tC'-)<

    l<.j, =: (eevl ~roSS rnte. of retu(Yl oYl i-perioot boylO!5

    \Il0lct 1YoM t +0 t+ I
    \,J

    = fv1o-x lAC c) 1-S) + ~ v (b~ ).(./)


    C,', I:>~x'

    ::: y-7+b-l-><
    H [c.) x/C 1-1-70 ]
    WA(?ve,. =- Xt :=) Xl
    ~ ~ :::-
    rio Pt+l
    ~ ,

    . (Vitti :- r"1H. P-t·t"1 == XHI (1 +11)


    pt 11-+1 Pt
    FOC: C: lAc- :=: )..,- ft He
    £: LA,,( ~
    -JA.-
    10' : ~Vb' (b~ X') = A1.(2..
    X': ~VX,(b~X') ::: r,4r\x' (1-1"11) + A(1+'i\)
    '=- (j.-}A.;\-f",) (1-t'U') <

    &we;lop ; b: Vb (b) X) ': A


    x: V x Cb,x) ::: A
    ~
    "f'vle'l'e, ().. if- ~ eq UCtti(lY1 S

    V'o ( b X)
    j
    ::: LAc - lA.t He.

    VxCb~x) -= V\c-U.lHc

    ~ubSfihAte, 'Into (3) ~

    ~ [tAcCt+1J-l)..eCtt1) HcCt-tI)] - CUcCi) - u./(t) \-\e(-t)]


    R
    (~)

    t+1

    A\so glAbShhxte, Into eLI-I:


    ~ [lJ e (t·t-\) - U.t( hi) He(t+\~ :::; f [iAc (t) - \).t (.t) HcLtB - It Hx,1 (1+71)
    ~

    1
    . '.'
    i

    1 '::: 12t (1+\1; -+ 1<-\;(1+11) U,t(t)I-\)('(,t)


    At

    1-12,,(1-\-'1() At: Vt,tLt) Hx'(t)


    12-1,(1+'")

    N:tte of (efurV"\ 'In MUYllt'-(


    1;
    ..,y f iflF lGlhon .:= f 0.1vj ('f ,'vtC'Y1(!<1
    ~
    {ecflects ',' &.;unh'~ ~'21 of Milne"I"
    ?'/
    ('\Z:i;1 gM - 1 ) At = lA.tl:t) ~hc'(t') /' q ~v .~
    {v <l< '/ we C.&~5tn"t cd- ~.tc<h(mikl0(ti,l")""
    . (q)
    ~'~,~~) At ~ ~(t~
    C+)

    CoS'f" = MrusiYw)., l?eVle-fit Otrecvt- {\1(IY1(l'1 bcd?lIlU-$ Iv'-ld{0:>fV1 t +0 id

    t \vie cost 0 f VJoldi"-'j fvlone~ bOlla Yl(.1.g ,'Mteaot of bOvletg

    B") €q,LlllibviuM
    At S~ 9-tv.-tl,: t;a (I''lL\'

    R = ~-' > 1 ' (10)

    ~ = fCI2...,)
    Pot;
    ce < +
    l' GOllt @~t: ~t := ti; + 13tH + Mt-l'1 -M;t.
    1<t p"

    trJ;!eJfl- 13-t =- ~OV~ "f\cU\:;ted Vl(iSS tv w p;ivate" £eOoy

    (V\~ :::- gwck of c<,lYyeVlc'1 ~t 00l/t rS5u.e~ 0.+ ~ b~/tJv1i~ 0.(- HA1.l.. t.
    Eq,l,tHi brilA.tv1 AHOCtl;\iot'
    l-I H ; J\!1O-x L
    0() i
    ~ v.. (Ct~,i.,) -l- ~~oppi~- "TIMt MOcUt
    t"o-
    1M. MovIe&{ (,.f 1tu Unli1\( Fh
    ~:t )..,1;; + s~ :=0 i

    St ::: H (c~ 7(VI~:I) I

    GArJev'e, H::. fn of thL Dr'Iott of tlMJ... y()vl ~pelllOl oY1 ~\twppl~

    (\-1M I '" rettt loedanU,.


    --p;

    Govt:

    bo Yyowl "5
    ( GOfl,;l :rsSI'\ e- )

    iJ Govt tltloose<; policie-s


    '2.) HH cMOOs.eS COYl)UrYIpOOYI o.IloCa1l0Vl
    ~
    h-oM (q) ;

    (rz.", - 12,.,-\;) .A~ -+ U.«(;l) H!f> (ti c= 0


    \::: l<t
    , C12.)

    , e) "~ho~+ f4t~ VS "L.CM~ tz.u";'


    -lI tv S'hActl( 60vt policieS cte~lgnecl1V ~~cribe Ct etet;riHe mearl',fl5 to C<. distiVlC:hoV\

    ~ DlA1L,ONleS In - *u 16(w(t Yl..u" (In-d-iAA c<ctte)


    \ lon~ run CS+-o.t-iOflOrvr eq,tidiloYiulV1)
    tvJe.

    ~
    (j) 'b\aHOVl afli ~ q,lA",li IrNiUrIl
    /.--------~-----------------_.-

    ~~
    A!,SIJ.ML
    J 0t "" g 'dt ~ 0 .7
    =r
    ~
    'Co\; "[" ~ {lO t t21l.lM l
    '1ft ~ 1
    6t ::=
    f.? £:>0 '", '" 13
    '---
    ~

    we. ltlcwe..- enwglt\ tret. policies- vClvlCtWg +0 d-isc,uSS '2 altemarive (YleC(Y1if1~S
    ~

    "open (V\Ctvke t ope-@-flOYlS,

    ~
    MJ(V) (';j):
    1R = J..
    (b
    6-
    =" ~
    1
    8q,W lilMliM Gn1ss !GeAL
    ~tetest ~te.
    16-
    h-01Y1 (12.) : ~ = FCC, ~M)
    Po\; ~ ~-1
    =- f (12...)

    we \riMe ~upp(esseo\ -the COYIS-tt:tVlt G g·R "If)~' fv;Or1e~.,. OeM'CWle\, fVt

    fC12 M } 'If) c\. s+anoYl~ €qlillik;NiulV).


    ~

    - Given -iiAe poliClf \Io.~a\;7Ie..s Cq, ?:"e) '/ thig eq.lAtHiOY1 oIe-ref/YlIVl€-S 1<",.
    II
    SWtiOYJC«f (7,lJe of rernrr. 0() 6LliY'enU( .

    q-! net d,.e..fici t


    g- -c, + e, (\<-1; :: gross ctL.fkit
    12.
    tUZ",') (1-F!M) == liAte. of geignlo-ra.~ reVeYlvl€.g t-oMp,'in~ eu.rr{!ncy.
    J'i v-y--...J
    bale"of- \flHanon\-D-x fO,{Q..
    IYlt-lo.liun-W,
    @ InHittt Date. (-t-i Me. 0)
    At b= 0 ,

    --'J Give,Vl . fht, poliCL( pOtro/Vletels [g, t., to, e,)


    the- ',Y)Hittl ~\vo<s e,o t Mo

    -4"-00
    -
    EJ)G • U(Ct,..lt) = ~
    1-b
    1-6
    +
    1-00

    .-
    H0 t
    , ~) = 1+
    Ct
    (V1'~1
    Pt

    Let- ~ ::: 0.'1"


    ~ ::: O.':l-

    d] :::-
    0,5

    c., OA
    ==
    ~

    use (11)
    Q'

    = 0

    hUrVI ettCn) - ~+atiOi1CN'1 SC{,il\l~riVM (L-0\1lj gun)


    Ve-BClt ISUfp\l.tS

    If r)i. Heir ~ y--z: -t 0 [f2..-1) > 0


    jZ-
    1k <;:Vllflus:::>'> ~-I + 6(j2.-1) t:... 0
    rz

    hoM cet. ('1'\-"): - ~VioV't-eu(1

    ~ -¥(,-)_(~ ... 'o-+6oJ+-\


    @ 10 MOrle1th'y VoctY"lVles
    1") ~ v.anti~ Theoy\.f of MO(ley
    eq,.C 1£\-)
    -'» Leti,vif\.9 all o-r tYle oitley p()ffiMetey"g of fW.. fYlockt -Axeet lInvlucti-j -fh..Q.,

    fisca..l po\iCL( potaMetey;s) 9; t} ZOJ 6)


    ~
    1M b-t SOMe, .fo.c,tv'f ).. :>
    c 1

    .& == fCIZ M )- (0 - ~,,+ 8 + .§.


    0 )

    ~ ~ ~
    \/'r\tI',s \ntey"ec.t
    -.....J
    o

    '2.) ~v.st~\Vled.. Oeficits CGlwe Inflation


    1..-:, vallAtg of' g~ss cU.fici+ C'aVl tJe, t'iI'1Clr1C£o\ with e",'I11ey low 1<... OV Vli9V\ 1<""
    (b> ~ i ve fi vi + -::») 112M ~) rV\.f laJioYl :::: (1 L J<M) 1

    (~-'t)';- !CCl.-,\)
    I - - - r - - - - - + + - - (I~- t) -to ~ (f{-1)

    g- i~ =
    ~

    oe·{1c;jj-
    1J) Fi scaA Pye(equ jg ite ~ of -zero JVl+ lat-ioil Polic y .
    .., 10 ~u.stz,.i(\ infla-\ion :: (1-iZ",) ;:. 0

    g- t. + e (12-1) - fCr<",) r1~t<"i)


    R '- .. _,.-~

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    ~

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