Presentation on theme: "Economics 311 Money and Banking Quiz 1- Inter Temporal Budget Constraint Spring 2010."— Presentation transcript:
Economics 311 Money and Banking Quiz 1- Inter Temporal Budget Constraint Spring 2010
Question Consider a person who earns $100,000 today and will expects to earn $59,000 in the future. Draw the person’s inter-temporal budget constraint if he had access to financial markets and could borrow and lend at an interest rate of 5%. What is the present and future value of his income stream? Label this points on your graph. Draw indifference curves consistent with the observation that the person consumes the same amount today as he will in the future, i.e. current consumption equals future consumption. How much will he consume today and in the future? Will he be a net borrower or net saver today? How much will borrow or save? Draw indifference curves consistent with your answers to parts (3) and (4). If he borrowed or lent by trading bonds, would the person buy or sell bonds? Suppose the government engaged in a fiscal policy where the person expected his taxes to increase in the future, i.e. future income is expected to decrease. An example of such a fiscal policy is an increase in current government spending financed by government borrowing. Show the effect on the person’s inter-temporal budget constraint. Depict the effect of this fiscal policy on current consumption/demand for good and services. Draw indifference curves consistent with your answer to (2). Is this fiscal policy likely to end an ongoing recession? Explain
Future Consumption Current Consumption 59K 59K + 100*1.05 = $164K 100K 80K 100K + 59K/1.05=$153,333.33 Net saver who sells bonds. Lower Expected Future Income Decrease in future expected income reduces current consumption.