In the Two-Period Model, Suppose a Household's Income in the First

question 21

Essay

In the two-period model, suppose a household's income in the first period is $50,000, income in the second period is $60,000, and the real interest rate is 25 percent.Draw a diagram showing the budget constraint.Now, suppose the real interest rate declines to 20 percent.Draw the new budget constraint.For the budget constraints you have drawn, be sure to show the values of the intercepts on each axis.If the household decides that its consumption in period 1 should always be one half of the present value of income, determine whether the household is worse off or better off because of the decline in the real interest rate.Show your work.

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