Consider a forward-looking individual who aims at maximizing his expected lifetime utility from his expected lifetime resources due to the presence of uncertainty. Assume the initial endowment of the individual is 4, and his expected labour income is in the sequence 2 Jo... His utility function takes the form U(C.) = aC -C where C, is consumption in period and 8 > 0. Assume the real interest rate, is constant but not necessarily equal to the discount rate p. Suppose that this individual lives for two periods, write down his/her lifetime expected utility function and intertemporal budget constraint. Carefully interpret each of these equations. Explain why the lifetime budget constraint must be satisfied as a strict equality. Prove that C++1=C++1 from the permanent income hypothesis (PIH) to show that consumption follows a random walk. Discuss the full implication of this result. How do changes in r affect expected consumption growth? Interpret the effect of r on expected consumption in the light of precautionary saving. With the theoretical prediction of PIH mind, explain how Friedman sought to reconcile the evidence about consumption from cross-sectional data with that from time-series macroeconomic data.

Consider a forward-looking individual who aims at maximizing his expected lifetime utility from his expected lifetime resources due to the presence of uncertainty. Assume the initial endowment of the individual is 4, and his expected labour income is in the sequence 2 Jo... His utility function takes the form U(C.) = aC -C where C, is consumption in period and 8 > 0. Assume the real interest rate, is constant but not necessarily equal to the discount rate p. Suppose that this individual lives for two periods, write down his/her lifetime expected utility function and intertemporal budget constraint. Carefully interpret each of these equations. Explain why the lifetime budget constraint must be satisfied as a strict equality. Prove that C++1=C++1 from the permanent income hypothesis (PIH) to show that consumption follows a random walk. Discuss the full implication of this result. How do changes in r affect expected consumption growth? Interpret the effect of r on expected consumption in the light of precautionary saving. With the theoretical prediction of PIH mind, explain how Friedman sought to reconcile the evidence about consumption from cross-sectional data with that from time-series macroeconomic data.

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.7P

See similar textbooks

Similar questions

Consider worker who is offered a salary bonus of $2,000 for each of the next two years if he or she erolls in a job training prgram this year. The total cost to the worker, including any forgone earnings, is $3,500. a. What is the internal rate of return on this investment? b. Would this be a good investment for someone with a discount rate of 6%
The demand D (in billions of £) for a bond with coupon rate 5% and face value FV = 1000, andtwo years to maturity as a function of its price P is D = 4000 − 2P. The supply in (billions of£) as a function of the price of the bond is S = 2P + 400. b) Suppose that the yield to maturity of the bond is i = 0.05. What is the quantitydemanded/supplied at this interest rate? What happens to the demand/supply of the bond asthe interest rate increases? Explain why. c) What is the equilibrium interest rate? d) Suppose that the bond trades at premium. Is there excess demand or supply? Explain.e) There is a business cycle expansion, so both supply and demand shifts. After the shift, thenew demand curve is given by: D = 4000 + X − 2P, whereas the new supply curve is S =2P + 200. For which values of X will the interest increase/decrease? Which values of X arein line with empirical data?
The demand D (in billions of £) for a bond with coupon rate 5% and face value FV = 1000, andtwo years to maturity as a function of its price P is D = 4000 − 2P. The supply in (billions of£) as a function of the price of the bond is S = 2P + 400. b) Suppose that the yield to maturity of the bond is i = 0.05. What is the quantitydemanded/supplied at this interest rate? What happens to the demand/supply of the bond asthe interest rate increases? Explain why. c) What is the equilibrium interest rate?
dw Explain fully what the equation says. 22. Prove that MFC = w + L-
Questions 2 Consider a forward-looking individual who aims at maximizing his expected lifetime utility from his expected lifetime resources due to the presence of uncertainty. Assume the initial endowment of the individual is A, and his expected labour income is in the sequence e Yo, Y Y,. His utility function takes the form U(C;) = aC -C? where C, is consumption in period t and 0 > 0. Assume the real interest rate, r is constant but not necessarily equal to the discount rate p. (a) Suppose that this individual lives for two periods, write down his/her lifetime expected utility function and intertemporal budget constraint. Carefully interpret each of these equations. Explain why the lifetime budget constraint must be satisfied as a strict equality. (b) Prove that C++1 = Ct + &t+1 from the permanent income hypothesis (PIH) to show that consumption follows a random walk. Discuss the full implication of this result. (c) How do changes in r affect expected consumption growth? Interpret the…
How does IRR (internal rate of return rule) differentiate from NPV (net present value rule) when deciding profitable investments? Is there a specific rule preferred or do they tend to give the same answer? Thank you so much im trying to understand them better.
Which of the following would ↑ the Qd of LF? Select one: O A. expected profit decreases. B. the real interest rate rises. O C. the real interest rate falls. D. the supply of loanable funds decreases. E. wealth increases. Clear my choice
1. Consider a household in the two-period consumption-savings model with well-behaved preferences over period-1 and -2 consumption given by u(c1,c2). Suppose that interest income in period 2 is taxed at a constant rate of T;. Assuming no initial endowment of wealth, Ao = 0, and the terminal condition A2 = 0, the household has the following nominal lifetime budget constraint: %3D P2c2 Y2 Pịci + = Y1 + (1+i(1 – Ti)) (1+i(1 – T;)) (a) Using indifference curve analysis, graphically locate the optimal choice (cj, cž). Label slopes and intercepts on your graph. (b) Write down the household's intertemporal optimality condition in terms of the gen- eral utility function. (c) In the United States, interest income received by households is taxed at a positive rate (i.e. T; > 0) while interest income paid by households is not taxed (i.e. Tị = 0). Suppose legislators propose complete elimination of this tax. Use economic logic and your answer from part (b) to explain how this policy change would…
Think of the entrepreneur with no initial resources (but s/he has a good idea=superior project). Recall that this person is living in a "perfect capital market" where the prevailing interest rate is 10%. Also suppose that the entrepreneur's "good idea=superior project" allows her/him to convert an investment worth $1000 at timel into a payoff of $6000 at time 2 a) Calculate the entrepreneur's MV1 = her/his time1 wealth b) briefly explain how she/he can achieve this wealth
How long it will take for the cost of the investment to be recovered from its benefits is referred to as profitability. O True O Falce
Suppose that a new machine tool having a usetul ife of onty one year costs $80.000 Suppose, atso, that the net additional revenue resulting thom buying this tool isexpected to be $12.000. The expected rote of return on this tool is Multiple Choice 40 percent 60 percent 30 percent 12 percent
E) There is a business cycle expansion, so both supply and demand shifts. After the shift, thenew demand curve is given by: D = 4000 + X − 2P, whereas the new supply curve is S =2P+ 200. For which values of X will the interest increase/decrease? Which values of X arein line with empirical data?