A typical worker will earn £300k in their youth and £600k in middle-age... lifetime, they must choose between two "goods": consumption in their youth and consumption in middle-age. When young, the worker has the option of putting their earnings in the bank at an interest rate of 0% - these savings can then be spent in middle-age. Alternatively, they can borrow money from the bank when young. This loan must be paid back in middle-age at a 100% interest rate. (a) What is the maximum amount of money the worker can borrow when young? (b) Draw a large graph with "consumption when young" on the vertical axis and "consumption in middle-age" on the horizontal axis. Represent the worker's budget set. Note: both axes should be labelled from £0 to £1,000k. (c) The government wishes to stimulate spending, and writes a law to reduce the interest rate from 100% to 0%. On the same graph, show the effect of this policy on the worker's budget set. Show the effect of this change on consumption for someone who was a borrower before the policy, breaking the total change into income and substitution effects. Assume that "consumption when young" and "consumption when middle- aged" are both normal goods. Further assume that if income and substitution effects work in opposite directions, the substitution effect is stronger.
A typical worker will earn £300k in their youth and £600k in middle-age... lifetime, they must choose between two "goods": consumption in their youth and consumption in middle-age. When young, the worker has the option of putting their earnings in the bank at an interest rate of 0% - these savings can then be spent in middle-age. Alternatively, they can borrow money from the bank when young. This loan must be paid back in middle-age at a 100% interest rate. (a) What is the maximum amount of money the worker can borrow when young? (b) Draw a large graph with "consumption when young" on the vertical axis and "consumption in middle-age" on the horizontal axis. Represent the worker's budget set. Note: both axes should be labelled from £0 to £1,000k. (c) The government wishes to stimulate spending, and writes a law to reduce the interest rate from 100% to 0%. On the same graph, show the effect of this policy on the worker's budget set. Show the effect of this change on consumption for someone who was a borrower before the policy, breaking the total change into income and substitution effects. Assume that "consumption when young" and "consumption when middle- aged" are both normal goods. Further assume that if income and substitution effects work in opposite directions, the substitution effect is stronger.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:A typical worker will earn £300k in their youth and £600k in middle-age..
lifetime, they must choose between two "goods": consumption in their youth and
consumption in middle-age.
When young, the worker has the option of putting their earnings in the bank at an
interest rate of 0% - these savings can then be spent in middle-age. Alternatively, they
can borrow money from the bank when young. This loan must be paid back in
middle-age at a 100% interest rate.
(a) What is the maximum amount of money the worker can borrow when young?
(b) Draw a large graph with "consumption when young" on the vertical axis and
"consumption in middle-age" on the horizontal axis. Represent the worker's
budget set. Note: both axes should be labelled from £0 to £1,000k.
(c) The government wishes to stimulate spending, and writes a law to reduce the
interest rate from 100% to 0%. On the same graph, show the effect of this
policy on the worker's budget set.
Show the effect of this change on consumption for someone who was a
borrower before the policy, breaking the total change into income and
substitution effects.
Assume that "consumption when young" and "consumption when middle-
aged" are both normal goods. Further assume that if income and substitution
effects work in opposite directions, the substitution effect is stronger.
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