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Final.answers.07 - Eco 402a Prof J Nilsen Final Examination...

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Eco 402a Prof. J. Nilsen 1 Final Examination December 20, 2007 True/False/Uncertain 6 points each . Credit will be given mainly on the strength of the logic justifying your response. Limit your answer to one or two sentences. 1. According to Milton Friedman, an individual seeks a constant marginal utility of consumption over his or her lifetime. True. In the simplest model (assuming certainty, fixed finite lifetime and perfect capital markets), an individual maximizing lifetime utility subject to a lifetime budget constraint wishes to achieve the same marginal utility in each period of his or her lifetime. 2. In the case of a financing a loan in an environment of asymmetric information, in the optimal contract the lender pays a cost to observe the outcome of the borrower’s project. This cost diminishes the lenders’ required return. Not exactly true. The lender is the party of the contract who pays to observe the outcome, but ex-ante demands to be compensated for this cost. Therefore the borrower must add it to the cost of receiving external credit. 3. In a closed economy without a government, it is well-known that income equals consumption plus savings. Therefore, if consumption is constant, savings must also be constant. This would be true if income were constant. But if income is not constant, constant consumption over a lifetime can be consistent with low or negative savings when income is low and high savings when income is high. Savings is done out of transitory income.
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