Answered step by step
Verified Expert Solution
Question
1 Approved Answer
Please answer the following question: 7. Consider a consumer with utility function um) = In x; for the income x; he enjoys in period t.
Please answer the following question:
7. Consider a consumer with utility function um) = In x; for the income x; he enjoys in period t. Assume that he receives no income in the rst two periods, but receives an income w > 0 in the third period. In addition, this consumer discounts his income stream (x9, x1, x2) according to u(xo, x1, x2)= In x0 + B8 In x; + B82 In X2 Where 5 e (0, 1) denotes his discount factor, and [3 S 1. We will note that this type of utility mction (commonly known as the ([3, 5)model) exhibits present bias when [i at 1. For parts (a) and (b) assume that, once the individual makes plans in period 0, he does not revise these plans in the future. a. Assume that he borrows during periods 0 and 1, and in period 2 he uses w to pay his debt. For simplicity, assume that he pays no interest during periods 0 and 1, but in period 2 he pays (1 + r)(xo + x1). Find his optimal consumption plan for (x0, x1, x2). b. Compare the total debt that, at period 0, a present-biased individual (with B at 1) and an individual without present bias ([3 = 1) plan to have at period 2. 0. While part (b) of the exercise focused on the debts that both types of individuals plan to have at period 2, the present-biased individual still has an opportunity to further increase his debt during period 1 given his time inconsistent preferences. Find his optimal consumption plan (x1, X2) at period 1. (1. Evaluate again the total debt of the present-biased individual against that of the decision maker who does not exhibit present biasStep by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started