Question

Question 3. Laura is deciding how much to consume in periods o, 1, and 2. Suppose Laura's income in period o is o, her income in period 1 is y, and her income in period 2 is ay. The price of consumption in period i is p. Assuming the interest rate is r, and consumption in period i is denoted c, set up Laura's intertemporal budget constraint, expressed in future value.

Answer 1

Intertemporal Budget constraint:

The price level in period 1 will be P1*(1+r) in period 0

The price level in period 2 will be P2*(1+r)^2 in period 0

The income in period 1 will be y1*(1+r) in period 0

The income in period 2 will be y2*(1+r)^2 in period 0.

Budget constraint:

P0C0 + P1C1+ P2C2 = y0 + y1 +y2

P0C0 + P1(1+r)C1 + P2(1+r)^2C2 = y0 + (1+r)*y1 + (1+r)^2*y2