Asked by Amina Shermatova on Jun 08, 2024
Verified
Will Wisp will live for exactly two periods.His utility function is U(c1, c2) c1c2, where c1 is consumption in period 1 and c2 is consumption in period 2.He will have no income in period 2.His income in period 1 is $80,000.If the interest rate rises from 10 to 12%:
A) his savings will increase by 2% and his consumption in period 2 will increase.
B) his savings will not change but his consumption in period 2 will increase by $800.
C) his consumption in both periods will increase.
D) his consumption in both periods will decrease.
E) his consumption in period 1 will decrease by 12% and his consumption in period 2 will increase.
Utility Function
A mathematical representation that ranks an individual's preferences over a set of goods and services, showing the level of satisfaction or utility those goods or services provide.
Interest Rate
The percentage of principal charged by the lender for the use of its money or the return earned on deposit funds.
Consumption
The use of goods and services by households or individuals, typically measured to understand economic activity and consumer behavior.
- Examine the effect of interest rates on the choices related to savings and investments.
- Obtain an understanding of the way utility functions represent preferences of consumers for consuming now as opposed to later.
- Understand the impact of interest rate fluctuations on consumption trends through the lens of the substitution effect and income effect.
Verified Answer
DB
Dingus BenningtonJun 10, 2024
Final Answer :
B
Explanation :
As the interest rate rises, Will Wisp will save more because his marginal propensity to consume is less than 1. However, his savings will not increase by 2% because we are not given any information about how much he saves from his income in period 1. We only know that his income in period 1 is $80,000.
Therefore, his savings will not change (since we don't have any specific information about his savings behavior), so option A is incorrect.
Option C is also incorrect because his income in period 2 is zero, so he cannot consume more in both periods.
Option D is also incorrect because we are told that his utility function is strictly increasing in consumption, so he would not choose to decrease his consumption in either period.
Option E is incorrect because his consumption in period 1 is not affected by the interest rate.
Therefore, the correct choice is B, that his savings will not change, but his consumption in period 2 will increase by $800.
Therefore, his savings will not change (since we don't have any specific information about his savings behavior), so option A is incorrect.
Option C is also incorrect because his income in period 2 is zero, so he cannot consume more in both periods.
Option D is also incorrect because we are told that his utility function is strictly increasing in consumption, so he would not choose to decrease his consumption in either period.
Option E is incorrect because his consumption in period 1 is not affected by the interest rate.
Therefore, the correct choice is B, that his savings will not change, but his consumption in period 2 will increase by $800.
Learning Objectives
- Examine the effect of interest rates on the choices related to savings and investments.
- Obtain an understanding of the way utility functions represent preferences of consumers for consuming now as opposed to later.
- Understand the impact of interest rate fluctuations on consumption trends through the lens of the substitution effect and income effect.