1. In this question we want to evaluate the effect of Social Security income on retirement savings of Americans. The average American earns around $1.5 million during their working life. Of this, they are allowed to save 17.5% tax free in a 401(K) account, and consume the remainder in their working years. 401(K) account earn an average 9% interest per year.
a. Draw a graph of consumption (C) and retirement (R) with the information provided in the question. Make sure to label all lines, intercepts, and slope. On the graph, label the consumption level American choose to have.
b. Social security provides a fixed amount of retirement income to all Americans no matter their private savings. On the graph above, draw consumption/retirement budget constraint with social security income. [Notice, that during working years, an individual cannot borrow against their future social security income.]
c. What do we mean when we say social security crowds out private retirement savings? Answer the question using an income and substitution table to show how Social Security income affects consumption and retirement savings.