Assignment 02 Question: Ali obeys the two-period Fisher intertemporal model ofco

Question

Assignment 02

Question:

Ali obeys the two-period Fisher intertemporal model ofconsumption. Ali

earns Rs. 200 in the first period and Rs. 400 in thesecond period.

A. If Ali consumes Rs. 280 in the first period and Rs.300 in the second

period, what is the interest rate?

B. Now if Ali's consumption changes in such a way thathe consumes

Rs. 300 in the first period and Rs.280 in the secondperiod, then

calculate the new interest rate?

C. Suppose there is an increase in Ali’s income infirst period, what will

be its impact on his consumption in both periods and onbudget

constraint? (Note: Ali’s consumption in bothperiods is on normal

goods)

(Marks = 6+6+3)

Explanation / Answer

A) First period Y1=200 C1=300 Second period Y2=400 C2=280 S= Y1– C1 S = 200–300 C2 = (1+r) S + Y2 280 = – 100 – 100r + 400 100r = 300 – 280          = 20 r = 20/100 = 20% b)In the firstperiod       Y­­1=200                       C1=280            In the second period     Y2=400                       C2=300 S= Y­­1- C1 S= 200-280=-80 C2= (1+r) S+ Y2 300= (1+r)-80 + 400 300 = -80-80r+400 80r =400-80-300 = 20 r= 20/80=1/4=.25 So the interest rate is 25%

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