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Due to popular demand, as well as this general TL approach to calculus:
I’ve decided to concentrate on less math-intensive ideas for now.
Question: Are Bonds a Good Thing for Kids?
One common form of gift giving is bonds. For those of you unfamiliar with bonds, they’re essentially tou loaning money to somebody for a fixed rate of interest. However, we’re not looking at this aspect of bonds: instead, we’re looking at gift bonds. These are bonds that may be purchased to give to somebody: for instance, grandparents may give kids a $500 bond for their birthday, except it delivers in 5 years, or something like that. Basically, the kids do not get the $500 until that time. It is thought that by doing so, the kids will be “forced” to save money for the future, thus encouraging good spending habits.
But is this really the case?
I will use this question to help explain an economic model-intertemporal choice.
Intertemporal choice relies on two very simple preferences: firstly, that people can lend money at a certain rate of interest, and secondly, that people can borrow money at a certain rate of interest. In the case of a bank or bond, usually the rates are different, but for purposes of this example we will assume the rates are the same.
Let’s consider this idea: Firstly, we know that a person has a choice between spending all their money, saving all their money, or something in between.
Now, what actually happens when we give them $500 10 years from now?
To explain what happens, we’re going to use the model of intertemporal choice:
M1 + (M2/1+r) = C1 + (C2/1+r)
Where:
M1 = the amount of money that we have now
M2 = the amount of money we have a few years down the road
C1 = the amount of money we’re going to spend now
C2 = the amount of money we’re going to spend later.
r = the rate of interest
So when we get $500 a few years down the road, we change the equation like this:
M1 + (M2+500/1+r) = C1 + (C2/1+r)
So what does this imply for C1 and C2?
M1 obviously cannot change-we can’t really change the amount of money we have right now. We can change how much we’re spending now and how much we’re spending later.
Just by looking at the equation, we can something immediately: an increase in M2 will change C1 and C2 upwards. This means that we would spend more money now (as well as in the future) than we currently do were we to get $500 in the future. Why is this the case?
Think about it: economics is often said to be the mathematics of common sense. If you were promised $500 down the road, and suppose you really wanted to buy something-let’s say, prostitutes. You know that this particular prostitute ten years down the road is going to be not very attractive, so you want to buy this prostitute now. But you only have a fixed amount of money now-how could you possibly afford the prostitute? The answer is, you borrow money. Because you know that you’re getting a certain amount of money in the future, you can borrow money at a rate of interest and pay it off with the money you’re getting in the future.
In other words, you borrow money to pay for the prostitute now, knowing your debts will be covered in the future. Basically, you actually increase your spending habits. This doesn’t seem to be very going very well with the goals of the gift bond.
But consider this: gift bonds are usually given to kids. And last time I checked, it was very hard for a kid to get a loan from anybody at a reasonable or even semi-reasonable rate of interest. So how does this affect our equation?
We can use a graph to analyze this:
As you can see, the red-crossed out sections are areas that signify we can no longer borrow, i.e. spend more money than we have. Because of this, the giving of the bond does, in fact, increase the total amount of money that we save. So perhaps gift bonds aren’t such a bad idea after all.
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Do you know anything about the strength of various economics/business programs? I'm currently deciding between Mathematics/Economics at UCSD and Mathematical Finance at UCSB. I want to sort of do all three, meaning I'd minor in finance at UCSD or minor in econ at UCSB.
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i dont understand
you cut off part of the equation coz the kid cant borrow? doesnt that affect the entire equation (ie make it less meaningful/relevent)
if he cant afford X now, and cant borrow, then he cant spend money
but if you give him the money now and he wants a prostitute then whats stopping him from spending now
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On November 25 2009 04:50 biomedical wrote:
i dont understand
you cut off part of the equation coz the kid cant borrow? doesnt that affect the entire equation (ie make it less meaningful/relevent)
if he cant afford X now, and cant borrow, then he cant spend money
but if you give him the money now and he wants a prostitute then whats stopping him from spending now
Firstly, here's what you need to understand. It's not about purchasing a prostitute, that was an example. Secondly, he has a certain amount of money as it is. He could very well be spending that money on a prostitute. That amount of money is what we call the endowment point, and it is the point on the graph. Now normally, you could borrow money, which means you would go further down the curve. Of course, because I said that kids cannot borrow money, we ignore all parts of the demand that would go beyond that point. As a result, I crossed out those portions of demand that would require us to borrow money.
There's nothing to stop him from spending now. It depends on the person's preferences. I am making the argument, however, that if you give somebody a bond (i.e. money in the future) and you still allow them to borrow, that you are not encouraging them to save money-instead, you are encouraging them to borrow money to buy things now. Keep in mind that people would prefer to have a dollar now than a dollar in a week, etc.
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On November 25 2009 04:09 meeple wrote:
What about inflation?
Inflation isn't accounted for in this model because it varies, and is dependent on macroeconomic factors. This is a purely microeconomic cutesy thing.
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On November 25 2009 04:09 jalstar wrote:
Do you know anything about the strength of various economics/business programs? I'm currently deciding between Mathematics/Economics at UCSD and Mathematical Finance at UCSB. I want to sort of do all three, meaning I'd minor in finance at UCSD or minor in econ at UCSB.
economics and business are two different sorts of things...
Business and Finance are fields of studying how to run a business, how to determine is a business is profitable, and tools a business can use to raise money. It involves things from economics, such as price discrimination, discounted cash flow, and interest rates of return, but also includes things like marketing, accounting, and administration, which have little or nothing to do with economics.
Economics is the study of why people do things from a resource-based and rational point of view. While it is popularly conceived as being things like business, US Treasuries and bonds, interest rates, etc, it is more of a methodology of doing something. For instance, in the field of health economics, its not necessarily about money, but time, or resources in general, or even just effort. Economics seems to be really unlikely from many people points of view-namely, the idea that many, many diverse people can all agree to a similar price for a good-but it happens.
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On November 25 2009 04:09 jalstar wrote:
Do you know anything about the strength of various economics/business programs? I'm currently deciding between Mathematics/Economics at UCSD and Mathematical Finance at UCSB. I want to sort of do all three, meaning I'd minor in finance at UCSD or minor in econ at UCSB.
Economics is not the best major if you are seeking a job right out of undergrad. It is not the worst either and you can find stuff to be sure, but its not as good as finance or even accounting. Economics is better only if you see yourself writing articles for publishing. Pick up a copy of the American Economic Review sometimes, check out those articles and see if you fall asleep or are excited.+ Show Spoiler + For full disclosure, I did a double major in econ and math, but knew all along I wanted to go to grad school for econ. Got my phd and I now work in finance anyway.
To your question about the schools: as far as I know UCSD is better in economics; no clue about math or business, but that should be easy to find online.
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EPT![[image loading]](http://img69.imageshack.us/img69/8577/fuuutility.jpg)
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