325_PracticePS10_Soln

325_PracticePS10_Soln - Department of Economics University...

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Department of Economics University of Maryland Economics 325 Intermediate Macroeconomic Analysis Practice Problem Set 10 Suggested Solutions Professor Sanjay Chugh Spring 2011 1. Consumption, Savings, and Financing Constraints. Because the consumption expenditures that occur later in an individual’s lifetime are typically on “bigger-ticket items” (e.g., cars, refrigerators, etc.) and thus more expensive, an individual often has to begin planning for his/her future consumption expenditures well in advance of their actual purchase and use. In contrast, consumption expenditures during the earlier years of an individual’s life are predominantly on “smaller” items (e.g., movies, food, entertainment, etc.) and thus might not require as much “advance planning.” We can analyze this idea in a two-period representative consumer framework. As always, suppose the representative consumer has utility function of period-1 consumption and period-2 consumption given by 12 (, ) uc c . Naturally, period 1 is the “early stage” of an individual’s economic life, and period 2 is the “later stage” of an individual’s economic life. Suppose the financial assets that individuals have at their disposal are “stocks,” just as we studied in Chapter 8. The representative consumer begins period 1 with zero stock holdings (i.e., a 0 = 0). The period-1 and period-2 budget constraints of the representative consumer are thus 11 1 22 2 2 2 1 () Pc S a Y Y S D a ± ± ± ± in which the rest of the notation is as always: P denotes the per-unit nominal price of a consumption good (in a given time period), Y denotes the nominal income the consumer earns (in a given time period), S denotes the nominal price of each share of stock (in a given time period), and D denotes the per-unit nominal dividend each share of stock pays (in a given time period). Because period-2 goods are weighted more towards “big-ticket items,” consumers typically have to borrow to purchase them. This means that asymmetric information issues may be a factor in lenders being willing to extend credit to consumers for their period-2 purchases. Suppose the financing constraint (aka credit constraint) that has evolved in markets to deal with these information issues is Sa .
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325_PracticePS10_Soln - Department of Economics University...

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