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Lecture Notes 6 - Consumption in time two periods of life...

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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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