Question

17.

Mr. Thomas has $210 income this year and $180 income next year. The market interest rate is 5% per year. Mr. Thomas also has an investment opportunity in which he can invest $70 this year and receive $90 next year. Suppose Mr. Thomas consumes $90 this year and invests in the project. What will be his consumption next year?

$300

$358

$300

$322

Answer 1

Mr. Thomas has $210 income this year and he consumes $90 this year

Therefore money left with Mr. Thomas for investment this year

= Income this year – consumption this year

= $210 - $90 = $120

Mr. Thomas has an investment opportunity in which he can invest $70 this year and receive $90 next year

But money with him for investment is $120, therefore remaining amount of $120 - $70 = $50 can me invested on market interest rate of 5% per year

Therefore proceed from investments next year

= Return from investing $70 + $ 50 * (1+ 5%)

= $90 + $52.50 = $142.50

Mr. Thomas has $180 income next year

Mr. Thomas’s consumption next year = proceed from investments next year + Mr. Thomas has $180 income next year    (We assume that he will consume all of his wealth in the next year)

Mr. Thomas’s consumption next year = $142.50 + $180

= $322.50 or $322 (nearest whole number)

Therefore Mr. Thomas’s consumption next year will be $322