Please leave only well motivated answers with relevant figures, terms and equati
ID: 1209605 • Letter: P
Question
Please leave only well motivated answers with relevant figures, terms and equations if needed.
a )Anna lives in two periods and have an income of 500 000 per period. How large is Annas consumption if both the subjective discount rate and real interest is 5 percent?
Assume that Anna gets an one-time raise of 100 000. How does this effect her consumption?
Does it matters if the raise happens in period 1 or period 2?
b) What does subjective discount rate mean? How does you answers above change on question a) if the subjective discount rate is less than the real interest rate?
Explanation / Answer
To explain the answer of above question we would take the help of consumer theory with intertemporal budget constraint.The main assumption is two periods life.According to that theory Consumer’s choices are subject to an intertemporal budget constraint, a measure of the total resources available for present and future consumption.This is basically a two-period model Period 1: the present Period 2: the future.Notation Y1, Y2 = income in period 1, 2 C1, C2 = consumption in period 1, 2;S = Y1 C1 = saving in period 1 (S < 0 if the consumer borrows in period 1)
Period 2 budget constraint: C2=Y2(1+r)S=Y2(1+r)(Y1-C1)
Rearrange terms:(1+r)C1+C2=Y2+(1+r)Y1
Divide through by (1+r) to get the intertemporal budget constraint.
The intertemporal budget constraint is {C1+C2/(1+r)]=[Y1+Y2/(1+r)]
The L.H.S denote the present value of lifetime consumption and the R.H.S denote the present value of lifetime income.
So here Y1=500000 and r=5% so C1=Y1-S and as we don't have the exact concept about the savings so we dont know about the consumtion so more information needed to banswer the question