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

question 46

Essay

In the two-period model, suppose a household's income in the first period is $40,000, income in the second period is $30,000, and the real interest rate is 25 percent.Draw a diagram showing the budget constraint.Now, suppose the real interest rate rises to 30 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 equal its consumption in period 2, 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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