Question

QUESTION 2 (Total: 15 marks) Consider an overlapping generations model as discussed in Chapter 7. In which people live for 3 periods. People receive endowment y only when they are young and zero endowments during other times. The population growth rate is n>1. People can hold physical capital which yields return after two periods: each unit of capital generates X units of consumption goods after two periods and then capital disintegrates. Note it is impossible for an individual to observe the capital created by others. Assume no lending borrowing opportunities among individuals

Answer 1

(A) budget constraints of an individual born in time t is

at time t he will be young -- when he will enjoy his earning that means his consumption will be equal to the income

(i.e.) Y=C where Y is income and C is consumption

at the time of its middle age that is t+1 --- when he will try to save his income and will consume less so that he can live his life easily in the future , when he will not be at the stage to earn and need money to consume .

(i.e.) Y-C=S WHERE S > C ( savings is more than consumption )

at the time when he will be at his old age , he will consume his total savings partly at that time . As he will not be able to work more and will not have any source of income .

(i.e.) C>S ( Consumption will be more then Savings) as they will consume from the savings with no income .

(B) Returns on fiat money on one period will be less because at that point of time the individual will be having less income and more consumption and less savings and at two period he will get more returns on his his income and the savings .

(C) RETURNS on physical capitals will be more at the two period and less at the one period .

(D) To making the young people to hold more money they must invest in the physical capital more and less fiat money in there hand . So that they can be able to save more and by investing they will get more returns in the future at there old age .

(E) YES , BECAUSE by saving more fiat money and investing them on physical capital will lead to the easy life at the two period or in the old age .

(F) The role of possible financial intermediary in this model is to maintain the rate if interest , flow of capital and the inflation .