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problem set 2 - the start of the f rst period that is...

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Econ 1110 Spring 2008 Assignment 2: Consumption, Saving and Investment 1. Exercise 1 in [AB] (Numerical problems of Chapter 4) 2. Exercise 8 in [AB] (Numerical problems of Chapter 4) 3. Exercise 5 in [AB] (Numerical problems of Chapter 4) 4. (Credit Card Debt and the budget constraint) Most consumers face di ff erent rates for borrowing and lending money. Savings typically earn a lower rate of interest than the interest rate that consumers get charged for credit card debt. Moreover, consumers face credit lines. Draw the budget line for an individual who receives an interest rate of r for saving and gets charged R for borrowing, assuming that the individual has a maximum allowed amount of borrowing, M . 5. (The collateral e ff ect of housing on consumption) Suppose that an economic agent is a hypersmoother (wants to equalize consumption as much as possible across periods). Assume an interest rate of r = 0 . The agent lives for three periods and owns a house at
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Unformatted text preview: the start of the f rst period that is valued at P = 20 . Throughout we shall assume that the agent is not willing to resell the house, because she wants to leave it as a bequest to her children. However, she can use it as collateral for up to a fraction x ≤ 1 of its value. The agent’s income is 20 in the f rst period, 60 in the second, and 10 in the third period. (a) Compute the agent’s f rst period consumption, assuming that banks are willing to lend only up to xP of the house value. What is the critical value of x that will allow the agent to achieve perfect consumption smoothing? (b) Assume that x = 1 . Show that a decrease in the price of the agent’s house to P = 15 will leave the agent’s consumption plans una f ected. (c) Assume that x = 1 . Suppose that the price of the house drops to P = 8 . Compute the drop in the agent’s f rst period consumption. 1...
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