Sunday

April 20, 2014

April 20, 2014

Posted by **robson** on Friday, October 26, 2012 at 4:04pm.

1. Suppose you live four periods and earn income of $30,000, $60,000, and $90,000 in the first three periods, and then retire in the fourth period. Assume the interest rate is 0.

a. Suppose you want to consume the same amount in each period of your life. How much would you consume each period? Indicate in which periods you would save and dissave and in what amounts.

b. Assume now that, contrary to part a, there is no possibility for borrowing (i.e. the credit market is closed to you). Under this assumption, how much will you consume in each period? In answering this question, continue to assume that if possible, an even flow of consumption is preferred. (Note: you are assuming here that there are liquidity constraints.)

c. Assume now that you are still liquidity constrained, but you receive an increase in income of $13,000 in period 1. How will your consumption be affected in each period? Relate your answer to the problem of excess sensitivity of consumption to current income.

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