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Suppose that an individual gains utility from Consumption today (c1) and Consumption tomorrow (c2 ). There are only two periods - today and tomorrow. The
Suppose that an individual gains utility from Consumption today (c1) and Consumption tomorrow (c2 ). There are only two periods - today and tomorrow. The individual gains utility from consumption in each of these periods according to their utility function: U(c1,c2)=c11/2c21/2 Assume also that this individual has income in both periods. an income today (m1)=$100 and an income tomorrow (m2)=$200. An individual can always borrow $1 today, at the cost of $1(1+r) tomorrow, or can always save $1 today and receive $1(1+r) tomorrow. The interest rate (r) is equal to 20%. 15. Write down this individual's budget constraint. [1 point] 16. What is this individual's current utility-maximizing choice of c1 and c2 ? Show your work. [2 points] Suppose now that the interest rate increases to 40%. 17. What is this individual's new utility-maximizing choice of c1 and c2 ? How much of this change in c1 and c2 can be attributed to the substitution effect and how much to the income effect? Use the Hicksian Decomposition for these calculations. Show your work. [3 points] Suppose that an individual gains utility from Consumption today (c1) and Consumption tomorrow (c2 ). There are only two periods - today and tomorrow. The individual gains utility from consumption in each of these periods according to their utility function: U(c1,c2)=c11/2c21/2 Assume also that this individual has income in both periods. an income today (m1)=$100 and an income tomorrow (m2)=$200. An individual can always borrow $1 today, at the cost of $1(1+r) tomorrow, or can always save $1 today and receive $1(1+r) tomorrow. The interest rate (r) is equal to 20%. 15. Write down this individual's budget constraint. [1 point] 16. What is this individual's current utility-maximizing choice of c1 and c2 ? Show your work. [2 points] Suppose now that the interest rate increases to 40%. 17. What is this individual's new utility-maximizing choice of c1 and c2 ? How much of this change in c1 and c2 can be attributed to the substitution effect and how much to the income effect? Use the Hicksian Decomposition for these calculations. Show your work. [3 points]
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