Consider a forward-looking individual who aims at maximizing his expected lifetime utility from his expected lifetime resources due to the presence of uncertainty. Assume the initial endowment of the individual is 4, and his expected labour income is in the sequence 2 Jo... His utility function takes the form U(C.) = aC -C where C, is consumption in period and 8 > 0. Assume the real interest rate, is constant but not necessarily equal to the discount rate p. Suppose that this individual lives for two periods, write down his/her lifetime expected utility function and intertemporal budget constraint. Carefully interpret each of these equations. Explain why the lifetime budget constraint must be satisfied as a strict equality. Prove that C++1=C++1 from the permanent income hypothesis (PIH) to show that consumption follows a random walk. Discuss the full implication of this result. How do changes in r affect expected consumption growth? Interpret the effect of r on expected consumption in the light of precautionary saving. With the theoretical prediction of PIH mind, explain how Friedman sought to reconcile the evidence about consumption from cross-sectional data with that from time-series macroeconomic data.

Consider a forward-looking individual who aims at maximizing his expected lifetime utility from his expected lifetime resources due to the presence of uncertainty. Assume the initial endowment of the individual is 4, and his expected labour income is in the sequence 2 Jo... His utility function takes the form U(C.) = aC -C where C, is consumption in period and 8 > 0. Assume the real interest rate, is constant but not necessarily equal to the discount rate p. Suppose that this individual lives for two periods, write down his/her lifetime expected utility function and intertemporal budget constraint. Carefully interpret each of these equations. Explain why the lifetime budget constraint must be satisfied as a strict equality. Prove that C++1=C++1 from the permanent income hypothesis (PIH) to show that consumption follows a random walk. Discuss the full implication of this result. How do changes in r affect expected consumption growth? Interpret the effect of r on expected consumption in the light of precautionary saving. With the theoretical prediction of PIH mind, explain how Friedman sought to reconcile the evidence about consumption from cross-sectional data with that from time-series macroeconomic data.

ENGR.ECONOMIC ANALYSIS

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ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

Consider a forward-looking individual who aims at maximizing his expected lifetime utility
from his expected lifetime resources due to the presence of uncertainty. Assume the initial
endowment of the individual is 4 and his expected labour income is in the sequence
Yo.PP2His utility function takes the form U(C.)% =
in period and 0> 0. Assume the real interest rate, r is constant but not necessarily equal to
the discount rate p.
where C, is consumption
= aC -
Suppose that this individual lives for two periods, write down his/her lifetime expected utility
function and intertemporal budget constraint. Carefully interpret each of these equations.
Explain why the lifetime budget constraint must be satisfied as a strict equality.
Prove that C+1 = C; + &+1 from the permanent income hypothesis (PIH) to show that
consumption follows a random walk. Discuss the full implication of this result.
How do changes in r affect expected consumption growth? Interpret the effect ofr on expected
consumption in the light of precautionary saving.
With the theoretical prediction of PIH mind, explain how Friedman sought to reconcile the
evidence about consumption from cross-sectional data with that from time-series
macroeconomic data.

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Step 1: Define Intertemporal Consumption

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Step 2: Determine Lifetime Expected Utility and Budget Constraint

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Step 3: Determine the Consumption Following a Random Walk:

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Step 4: Determine the impact of change in interest rate

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Step 5: Determine Friedman theory and Reconciling Consumption Data

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