REVIEW_FINAL.pdf - Problem Set - Review Session E CON W3213...

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Problem Set - Review SessionECONW3213 - INTERMEDIATEMACROECONOMICSTA: Carlos Montes-Galdón1Robinson Crusoe and consumption1. Assume a worker who has to allocate his time between working L hours a day for a given wage, and “leisure”. Theworker has usual preferences: increasing and concave. He consumes everything that he earns each period, so, thereare no savings:Y=C. The worker can also choose to get education. If he is uneducated, he earns a low wagewL.If he gets education, he must pay a lump sum cost of education,ψ. Hence, he will earn a higher wage rate,wH,withwH> wL.(a) Write the budget constraint for every period if he is uneducated.In a diagram, with Labor in the horizontalaxis and output and consumption on the vertical axis, draw the budget constraint. Show how to represent thepreferences of the worker with the help of the indifference curves, and show the optimal choice of consumptionand labor.(b) Write the budget constraint if he is educated.(c) In a new diagram, draw the budget constraint and the optimal point that you derived in part 1. Add now thenew budget constraint when the worker is educated. Assume that the cost of education and the higher wage rateare such that the new budget constraint passes through the old optimal point. Show the new optimal point. Is hegoing to consume more or less? Is he going to work more or less? Explain your answers in terms of substitutionand income effects.2. Assume now that our worker has access to financial markets. Also assume that, in the first period of his life, the worker

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