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Unformatted text preview: 09/02/11 Consumption in time: two periods of life, working life (C1) and retired life (C2) A worker can earn 100K over his lifetime Interest Rates 10% If the consumer saves all earnings, he can possibly enjoy 110K in retirement Graphed with axis of time period, inter-temporal budget line Midpoint of line is where a consumer has spent 50% of his earnings in each time period Matter of preferences, how does a consumer value today versus future discount the value of the future Indifference curves illustrates preferences over time, slope illustrates willingness to consume today or save for tomorrow Change in interest rates: interest rates increase, the graph rotates on the x-axis, point on C2 axis can be higher opportunities are greater o Income and substitution effect inter-temporal two period model with an increase in interest rates (an increase of 10%) o Consumer spends more interest rate increases income (income effect) o Price of consumption today has risen the substitution effect encourages saving, spending less in...
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