5. Consider a two-period consumption model in which an individual's life time- utility is u(c1,c2) =ce. The individual earns I1 = 1000 in period 1 and re- ceives a government pension I2 = 800 in period 2. Suppose the individual can save or borrow at the net interest rate 10% (r 0.1). Assume that the price levels in both periods are one (p1 = P2 = 1). (a) Find the individual's optimal consumption level in each period. How much does she save or borrow in period 1?. (b) Suppose the interest rate goes up to 40%. Find the total, substitution, and income effects on period 2 consumption. Based on your answer, would you classify period 2 consumption as normal or inferior? Is it Giffen? (c) Suppose the government wants to adjust the pension to I, so that the individual is equally well off as before the interest rate change. Find I. Is I, larger or smaller than I2? Give a brief, intuitive explanation of this result.

5. Consider a two-period consumption model in which an individual's life time- utility is u(c1,c2) =ce. The individual earns I1 = 1000 in period 1 and re- ceives a government pension I2 = 800 in period 2. Suppose the individual can save or borrow at the net interest rate 10% (r 0.1). Assume that the price levels in both periods are one (p1 = P2 = 1). (a) Find the individual's optimal consumption level in each period. How much does she save or borrow in period 1?. (b) Suppose the interest rate goes up to 40%. Find the total, substitution, and income effects on period 2 consumption. Based on your answer, would you classify period 2 consumption as normal or inferior? Is it Giffen? (c) Suppose the government wants to adjust the pension to I, so that the individual is equally well off as before the interest rate change. Find I. Is I, larger or smaller than I2? Give a brief, intuitive explanation of this result.

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter17: Capital And Time

Section: Chapter Questions

Problem 17.2P

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