Suppose that good A provides more utility in the long run than good B, but it provides less utility in the short run. Cost of choosing good A is relatively small but come early, while the cost of choosing good B is larger but come late. Consider a choice between good A, which will yield 25 in the period when it is received (t=1) and 200 in the second period (t=2), and good B, which will yield 100 in each of the two periods. Assume an immediacy effect of =0.5 and there is no other discounting.

Suppose the consumption starts immediately (t=1):

a.Find the present value of utility streams for the good A. (4 points)

b.Find the present value of utility streams for the good B. (4 Points)

c.Which one would you prefer, the good B or the good A? Why? (2 points)

Suppose the consumption is delayed one period, so from the perspective oft=0:

d.Find the present value of utility streams for the good A. (4 points)

e.Find the present value of utility steams for the good B. (4 points)

f.Which one would you prefer, good B or good A? Why? (2 points)

g.How do you explain the shift in preferences once the base period changes? What is this phenomenon called? (3 points)

h.Can we explain this behavior using the discounted utility model (i.e. the delta model)? Why or why not? (2 points)