PS2_solutions_final

# PS2_solutions_final - DEPARTMENT OF ECONOMICS FALL 2009...

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Unformatted text preview: DEPARTMENT OF ECONOMICS FALL 2009 UNIVERSITY OF CALIFORNIA, BERKELEY ECON 182 Problem Set 2 Due in class on Thursday, September 17 th at the beginning of lecture . Students that show their work and write neatly will be graded favorably. Please write your full name, GSI, and section time on your problem set. 1. Intertemporal Approach to the Current Account This exercise reviews the intertemporal approach to the current account introduced in lecture 4. In particular, we will use a graphical representation of the theory to illustrate some key ideas. The following assumptions are made: we are studying a small open economy (remember this means that it takes the world interest rate r as given); there are only two periods, period 1 and 2, respectively; there is a single consumption good; the economy is endowed with output levels Y 1 and Y 2 in each period. a). Write down the intertemporal budget constraint for our small open economy, and explain intuitively what it means. ܥ ଵ ൅ ܥ ଶ ͳ ൅ ݎ ൌ ܻ ଵ ൅ ܻ ଶ ͳ ൅ ݎ Intuitively, our intertemporal budget constraint says that the present discounted value of our lifetime consumption has to equal the present discounted value of our lifetime income. b). Refer to Figure 2 in the lecture notes for global imbalances on the syllabus, explain intuitively why the indifference curve has a convex shape. The indifference curve derives its convex shape from the assumption of a diminishing marginal rate of substitution. Intuitively, it is tempting to think in terms of diminishing marginal utility leading to consumers wanting to smooth their consumption across periods. It is important, though, to keep in mind that diminishing marginal utility is neither necessary nor sufficient for a diminishing marginal rate of substitution. Loosely speaking, diminishing marginal utility is sufficient for a diminishing marginal rate of substitution only if the cross partial derivative of the utility function is “small”. c). Assuming consumer preferences are such that C 1 and C 2 are equal, solve analytically for consumption in both periods....
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## This note was uploaded on 02/07/2010 for the course ECON 182 taught by Professor Kasa during the Spring '08 term at Berkeley.

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PS2_solutions_final - DEPARTMENT OF ECONOMICS FALL 2009...

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