ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN: 9780190931919
Author: NEWNAN
Publisher: Oxford University Press
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Transcribed Image Text:Analysing Utility Function and Household Optimization
Consider a household with the following utility function representing their preferences
over consumption:
with
U = u(C) + Bu(C++1)
u(C) = exp(-aC), BE (0,1), a>0
where Ct and Ct+1 represent consumption in the current and future periods, respectively. The
household faces a two-period decision problem. They receive endowments of Yt and Yt+1 in the
current and future periods, respectively. The real interest rate is denoted by rt. Notice: The
utility function u(C) takes on negative values for all positive consumption levels. However, in
economic models, the absolute value of utility is less important than how utility changes with
consumption. A higher level of utility represents a more preferred outcome for the household.
Solving for Current Consumption Demand Function
Solve for the household's demand function for current consumption (Ct). Express Ct as a
function of Yt, Yt+1, rt, and the parameters ẞ and a. Discuss what happens to Ct when Yt and
Yt+1, increase and decrease.
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