Question

(10 marks) Consider the intertemporal model of consumption in which a consumer chooses between consumption in the current period (Co) and consumption in the future period (C). Suppose individuals can borrow or save at constant interest rate, r. Suppose Jane has an initial endowment of Co in the current period and C, in the future period. Suppose Jane prefers to save some of her current income (amount S1) to finance an expensive vacation in the future period. 8. (2 marks) Draw a graph illustrating Jane's intertemporal budget constraint and optimal consumption bundle a. b. (2 marks) Label Jane's initial endowment and amount saved in the current period. (3 marks) Now suppose the government imposes a mandatory savings plan. Under the plan, Jane must pay the government an amount, T, in the current period. In the future period, the government will pay Jane a payment equal to (1+r)T. Use your diagram to illustrate how the mandatory savings plan impacts the amount Jane saves in the current period. c. (3 marks) Suppose Jane's preferences stay the same but her initial endowment point is changed such that she borrows (not saves) in the current period. Use your graph to show how the mandatory retirement savings plan in part (c) would affect the amount Jane borrows in the current period. d.

Answer 1

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