# exe 2 - ECON 303 Name Intermediate Macroeconomic Theory...

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ECON 303 Name___________________ Intermediate Macroeconomic Theory Spring 2008 Dr. Dao Answer to Second Exam 1. Assume that Jeannie Drago is trying to allocate her consumption over two periods of life: work and retirement. Each period is to last 20 years. To simplify, assume that all income comes at time t 1 in the middle of 20 years of work, and all expenditures come at either t 1 or t 2 , 20 years later. Jeannie’s budget constraint is C 1 + C 2 /(1 + r/100) = Y 1 + Y 2 /(1 + r/100), where the real interest rate r is 100 percent (approximately 3.5 percent per year over 20 years). Jeannie’s preferences are to have equal consumption each period. a. What are C 1 and C 2 if Y 1 = 1 million and Y 2 = 0? b. What are C 1 and C 2 if Y 1 = 0 and Y 2 = 1 million (reflecting, for example, an individual who plans to come into a large inheritance late in life)? Do these answers depend on Jeannie’s being able to borrow against the inheritance? a. C 1 + C 2 /(1 + r/100) = Y 1 + Y 2 /(1 + r/100) C 1 + C 1 /(1 + 100/100) = 1M C 1 = C 2 = 2/3 M b. C 1 + C 1 /(1 + 100/100) = 1M/(1 + 100/100) C 1 = C 2 = 1/3 M Yes 1

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2. Assume that a car-rental company buys cars for \$20,000 each and rents them out to other businesses. The company faces a nominal interest rate of 10 percent per year, and car prices are rising at 6 percent per year. If cars depreciate at 30 percent per year, what will be the company’s cost of capital per car? Cost of capital = 20,000(.10+.30-.06) = \$6,800
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exe 2 - ECON 303 Name Intermediate Macroeconomic Theory...

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