Page 133 - DECO402_Macro Economics

Macroeconomic Theory

Notes Therefore, risk averter, on keeping his entire wealth OW fewer in bonds and fewer in cash, diversifies
his entire wealth.

Figure 14.3

This is the reason that he is called diversifier. He is not ready to face the risk until he has not the
expectation of expected result. However, risk averter gives the preference to liquidity in his mind,
which can only be rectified from only very high interest rates. However, the interest rate will be greater;
The demand of money will we lesser consequently, the rate of keeping the bond will also be as higher.
On the opposite hand, however the interest rate will be lesser; money demand will be as larger, and
consequently the desire to keep the bond will as lesser. It is shown in figure 14.3.
When interest rate increases, the slope of budgetary line increases. It is shown by budgetary line r
1
which on revolving reaches to r and r . Consequently, with the increment in interest rate the results
3
2
in proportion of risk are increased and budgetary line moves with touching very high indifference
curves. Lines r , r and r touch the curves l , l , l on the points T , T , T respectively. These points
1
3
2
1
2
3
3
2
1
trace the optimal portfolio curve OPC in the figure, which tells as the points move left to right side
upward, the expected results and risks are increased.
These touching input list also determine the portfolio trend of risk averter, as shown in lower part
of figure 14.3. When interest rate is r , then they keep OB bond and B W money. As interest rate
1
1
1
on increasing r to become r and r , the risk averter starts to keep more bond OB and OB money
2
3
1
2
3
respectively in their input list and converted the money into B W and B W on reducing. Figure also
3
2
shows that when there is increment in interest rate in equal quantities from r to r to r then risk
3
2
1
averter keeps the bonds in reducing quantities. B B < B B < OB . It also means thatwhen interest rate
3
2
2
1
1
increases then money demand comparatively reduces in less quantity. It’s reason is that bonds and
money are included in total asset of input list.
Figure 14.4
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