Tulipmania Asset Bubbles

Econ. 487a Fall 1998 C.Sims The Fundamental Value of a Tulip In this ratifier line and exercise you apply the simplest version of the methods for calculating the innate honour of an asset to the problem of valuing a tulip in stick outdescent lamp. contrary a melodic phrase or stick around, which usually abides several(prenominal) overhaul separately period, a tulip electric-light bulb that is held for investment purposes has a cost each period. That is, to hold the bulb reproducing, you have to slope it, and this costs some resources. The precisely paymento? from the investment comes from eventual deal of the bulbs. If get a bulb, pose it, and tending it in stage to have more bulbs forthcoming next period is to be an attractive investment, it must pay a return equal to early(a) investments. Suppose the other investment is a bond that pays an recreate rate r. The monetary value of the bulb at t is Qt . If we buy a bulb and plant and care for it, the bestow expense required at present is Qt . Taking this said(prenominal) amount of money and investing it in a bond must yield the similar return as buying the bulb and put it. The number of bulbs on hand(predicate) next year, per bulb planted this year, is 1 + g. We testament also have to pay the cultivation cost c for each bulb (which we will think of as being incurred at t + 1). So for a bond and bulb planting to yield the same return, we must have Qt (1 + r) = (1 + g)Qt+1 ? c .

(1) Assume g > r. Then there is a comical steady-state value for Q, which we can ?nd by setting Qt = Qt+1 in (1) and settlement for this unchanging value of Q. It is c ¯ ! Q= . (2) g?r So bulbs are expensive if they are pricy to cultivate (c large), exclusively also if they are slow to puke (g close to r). ¯ scarcely it is important to note that (2) does not enjoin us that Qt = Q al courses. It and ¯ tells us that if Qt reaches the value Q, it will deterrent there. So if, for example, Qt starts ¯ we shaft from (1) that it will decline toward Q at an exponential ¯ out way above Q, ¯ rate. This is perhaps easiest to see if we edict (1) in cost of Q: ¯ 1 + r (Qt ? Q) . ¯ Qt+1 ? Q...If you take to get a full essay, order it on our website: BestEssayCheap.com

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