Assume that a consumer lives for 2 periods. The consumer receives an endowment of £25,000 in period 1, and £17,000 in period 2. She pays a tax of 10% of income in both periods. The real interest rate in the economy is 5% (0.05). a) Write down the inter-temporal budget constraint of the consumer. Evaluate its slope and both intercepts. b) The consumer has a Cobb-Douglas utility function such that u = c,"c₂. Find the optimal consumption in periods 1 and 2. c) How would consumption in period 1 react if there is an increase in the interest rate? Note, you do not need to give a numerical answer but only explain the effect.
Assume that a consumer lives for 2 periods. The consumer receives an endowment of £25,000 in period 1, and £17,000 in period 2. She pays a tax of 10% of income in both periods. The real interest rate in the economy is 5% (0.05). a) Write down the inter-temporal budget constraint of the consumer. Evaluate its slope and both intercepts. b) The consumer has a Cobb-Douglas utility function such that u = c,"c₂. Find the optimal consumption in periods 1 and 2. c) How would consumption in period 1 react if there is an increase in the interest rate? Note, you do not need to give a numerical answer but only explain the effect.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Answer the given Question.
Transcribed Image Text:Assume that a consumer lives for 2 periods. The consumer receives an endowment of
£25,000 in period 1, and £17,000 in period 2. She pays a tax of 10% of income in both
periods. The real interest rate in the economy is 5% (0.05).
a) Write down the inter-temporal budget constraint of the consumer. Evaluate its
slope and both intercepts.
b) The consumer has a Cobb-Douglas utility function such that u = c,*c*. Find the
0.5
optimal consumption in periods 1 and 2.
c) How would consumption in period 1 react if there is an increase in the interest rate?
Note, you do not need to give a numerical answer but only explain the effect.
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