q1

Question 1 (10 marks) For this question assume that the inflation rate is zero and, therefore, that the nominal and real interest rates are equal. Consider a two period model of the economy and assume the real interest rate is 10% (R=0.10). The lifetime utility function of the household is: U = 103(Ctoday) + 103(cfuture)- Assume financial wealth today is fwday = $10,000, labour income today is ymday = $20,000 and labour income in the future is yfumre = $44,000. The Euler equation is: Grams = (1 + R), where R=0-10 Ctoday (a) Using the information given, write down the consumer's intertemporal budget constraint and provide an interpretation of it. Be sure to define all of the variables. (b) Suppose the household chooses the consumption stream of cmday = $20,000 and crume = $55,000. Is this consumption stream feasible? Justify your answer. Does this consumption stream maximise the household's lifetime utility? Justify your answer. (c) Find the household's optimal level of consumption today and in the future. (d) Now assume that the household is facing a credit/borrowing constraint, namely, that no financial institution is willing to lend to the household. Will your answer to part (0) change? Explain your answer fully