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Economics 402, Winter 2009Problem Set 3Suggested Solutions1. Credit ConstraintsAlex currently makes $500 at his lousy job. He is promised $5,000 at his sales jobafter he graduates from college. Alex currently spends all his income, but would liketo throw a big party for his friends before graduation. Unfortunately, his credit cardlimit is exhausted and his bank refuses to give him a loan.1.Draw Alex°s budget set and consumption levels he chooses today and in thefuture. How much does Alex save?Alex would like to throw a party and consume more than his income today, buthe cannot borrow. The most he can consume today is his current income, soAlex consumes his income today and his future income tomorrow. He is at acorner solution at the kink of his budget set. Since Alex neither borrows norsaves, his saving is zero. See Figure 1.c’c$5000$500Figure 1: Alex°s budget set and consumption levels2.Suppose now that Alex°s future boss calls him up and tells him that he raised hissalary to $6,000 per month. How does Alex°s consumption mix between todayand the future as well as his saving change? Is he better or worse o/ than before,or does his welfare not change? Draw the graph and explain brie±y.See Figure 2.Alex°s lifetime wealth increases, so he would like to consumemore in both periods. Unfortunately, he still cannot borrow, so he consumes
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