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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Assume that a carrental 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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 Spring '10
 DAN
 Net earnings, Permanent income hypothesis, Ken Downing, Jeannie Drago

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