1) Assume that a household is choosing how to allocate their income (Y) over the next two years for consumption (C). Assume that Y 2016 = $100,000 and Y2017 = $0 meaning they are going to retire at the beginning of 2017, except to die at the end of 2017 and wish to leave nothing for their rotten kids. Initally the interest rate (i) for both borrowing and lending is 10%.
A) Please construct the budget line with Y and C for this year 2016 on the horizontal axis and Y and C for 2017 on the vertical.
B) Please write the equation for the budget constraint in slope/intercept form.
C) What is the rate that the financial market place requires the household to exchange a dollar’s worth of consumption this year for a dollar in 2017?
D) Assume the household chooses C2017 (next year’s consumption) to be $40,000. How much can the household consume and save in 2016 as a result of this decision?
E) Assume the Federal Reserve lowers interest rates such that the rate indicated above falls from 10% to 5%. But the household insists that it wants consumption in 2017 to remain at $40,000. Please show this change in the budget constraint and determine how much consumption and savings in 2016 can be for the household to achieve its consumption goal C2017 = $40,000 for 2017.