490
PART SEVEN
ADVANCED TOPIC
plausible? Discuss. (Hint: Think about income and
substitution effects.)
8. Suppose you take a job that pays $30,000 and set some
of this income aside in a savings account that pays an
annual interest rate of 5 percent. Use a diagram with a
budget constraint and indifference curves to show how
your consumption changes in each of the following
situations. To keep things simple, assume that you pay
no taxes on your income.
a.
Your salary increases to $40,000.
b.
The interest rate on your bank account rises to
8 percent.
9. As discussed in the text, we can divide an individual’s
life into two hypothetical periods: “young” and “old.”
Suppose that the individual earns income only when
young and saves some of that income to consume when
old. If the interest rate on savings falls, can you tell what
happens to consumption when young? Can you tell
what happens to consumption when old? Explain.
10. Suppose that your state gives each town $5 million in
aid per year. The way in which the money is spent is
currently unrestricted, but the governor has proposed
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 Spring '10
 abijian

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