Question

12. Savings decisions Charles is a Nobel laureate who teaches economics at a university where he is paid a yearly salary of $160,000. He plans to take the next year off to write a book, so he won't earn any money next year. He is currently trying to figure out how much of this year's salary he should save for next year. Disregard any tax considerations, and disregard what happens after next year. In other words, assume that next year, Charles will consume whatever he saves, plus any interest, and that he's not thinking beyond next year. The following graph shows Charles's preferences for consumption this year and next year. Suppose initially Charles cannot earn interest on the money he saves. Use the green line (triangle symbol) to plot Charles's budget constraint (BC) on the following graph. Then use the black point (plus symbol) to show his optimum consumption bundle. Note: Dashed drop lines will automatically extend to both axes. 240 220 200 180 BC, 10% interest + Initial Optimum (0% Interest) 100 140 SUMPTION NEXT YEAR (Thousands of dollars) o BC, (50% Interest New Optimum (50% interest)

Answer 1

Intertemporal BC

(1+r)c1 + c2 = (1+r)*160,000 + 0

1.5c1 + c2 = 240,000

.

At eqm, BC is tangent to IC

A BC, (0% Interest) + Initial Optimum (0% Interest) CONSUMPTION NEXT YEAR (Thousands of dollars) o + BC, (50% Interest New Optimum (50% Interest) 0 0 20 40 60 80 100 120 140 160 180 200 220 240 CONSUMPTION THIS YEAR (Thousands of dollars)

When i = 0% , c1 = 60,000, c2= 100,000

Saving = 100,000 = Y-c1

i = 50%, c1= 80,000, c2= 120,000

Saving = 80,000

Table

Interest rate	saving
0	100,000
50%	80,000

Option 2)

saving falls, as interest rate rises , but it not happens always