Econ402_Solutions_Set3

Econ402_Solutions_Set3 - Economics 402, Winter 2009 Problem...

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Economics 402, Winter 2009 Problem Set 3 Suggested Solutions 1. Credit Constraints Alex currently makes $500 at his lousy job. He is promised $5,000 at his sales job after he graduates from college. Alex currently spends all his income, but would like to throw a big party for his friends before graduation. Unfortunately, his credit card limit is exhausted and his bank refuses to give him a loan. 1. future. How much does Alex save? Alex would like to throw a party and consume more than his income today, but he cannot borrow. The most he can consume today is his current income, so Alex consumes his income today and his future income tomorrow. He is at a corner solution at the kink of his budget set. Since Alex neither borrows nor saves, his saving is zero. See Figure 1. c’ c $5000 $500 2. and 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. more in both periods. Unfortunately, he still cannot borrow, so he consumes
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his current income today and his future income tomorrow. The normality of both c and c 0 keeps Alex at the corner. His saving is still zero. Alex is now better o/, because he enjoys higher consumption in the future period. c’ c $5000 $500 $6000 I 1 I 2 > I 1 Figure 2: An increase in future income 3. Back to the original situation (with $5,000 salary): we now study an increase in the interest rate for deposits. First, graph a situation where the interest rate does his welfare change? See Figure 3. Graphically, the increase in the slope must not be so large that also remains the same. Alex is not a/ected by the increase in the interest rate. Neither consumption decision changes, so his welfare does not change, either.
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Econ402_Solutions_Set3 - Economics 402, Winter 2009 Problem...

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