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**Unformatted text preview: **Graduate Macroeconomics I: Midterm Prof. Vollrath Answer Key Problem 1 : (1 + r ) = 1, so people want c = c 1 , assuming they are not liquidity constrained. A) Type A people have a budget constraint of c A + c A 1 4 / 3 = 4 + 4 4 / 3 = 7 . (1) If unconstrained, then c A = c A 1 , and this would mean c A = 4. As they have 4 in the initial period, this is feasible and so they will consume c A = 4. Therefore s A = 0. B) Type B people have a budget constraint of c B + c B 1 4 / 3 = 1 + 3 4 / 3 = 13 / 4 . (2) If unconstrained, they would choose c B = 13 / 7. But this is greater than first period income (1), so it is not feasible with the liquidity constraint. Therefore c B = 1 and s B = 0. C) Lifetime income is unchanged, meaning that type A people still have 7 and type B people still have 13/4 in resources to spread across the two periods of their life. (1 + r ) is the same, so people still want consumption to be equal in the two periods....

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