Assume that there are two periods in my life; one in which I work and earn income,

and one in which I am retired and earn no income. I can earn $250,000 during the

work period and nothing in the retirement period. Consequently, I must both save and

consume in the work period so that I can consume during retirement. My savings earn

10 per cent interest.

i. Use a graph to demonstrate my budget constraint.

ii. On your graph, show the optimal point such that my consumption in the work

period equals $150,000. What is the implied level of consumption in the

retirement period at this point?

iii. Now, using your graph from above, demonstrate how I will be affected by an

increase in the interest rate on savings to 15 per cent. Discuss the role of income

and substitution effects in determining whether I will increase or decrease my

savings in the work period after this increase in interest rate.