Consumption and Savings

Question 1

What is the objective of the Two-Period Model?

Answer 1

Trade-off between current and future consumption.

Question 2

What is the formula for the Current Period Budget Constraint?

Answer 2

C + S = Y - T

Question 3

What is the formula for the Future Period Budget Constraint?

Answer 3

C’ = Y’ - T’ + (1 + R)S

R real interest rate
S savings

Question 4

What is the formula for the Lifetime Budget Constraint?

Answer 4

C + C’/1+R = Y + Y’/1+R -T -T’/1+R

Question 5

How do interest rates affect savers?

Answer 5

Higher interest rates → save more (substitution dominates).

High rates discourage borrowing less investment Ad down

If IR low then inflation leads to reduction in purchasing power as value for P decreases over time

Question 6

How do interest rates affect borrowers?

Answer 6

Higher interest rates → save less (income dominates).

Question 7

What are Perfect Complements Preferences?

Answer 7

C= c’

If the future consumption (c{\prime}) is higher than current consumption (c), it would not satisfy the condition for perfect complements, because for perfect complements, the consumer must consume exactly the same amount in both periods: c = c{\prime}.