Precautionary saving and prudence The Query to Example 17.2 asks how uncertainty about the future might affect a person's savings decisions. In this problem we explore this question more fully. All of our analysis is based on the simple two-period model in Example 17.1.
a. To simplify matters, assume that
b. Use Jensen's inequality (see Chapters 2 and 7 ) to show that this person will opt for
c. Kimball" suggests using the term "prudence" to describe a person whose utility function is characterized by
d. In Example 17.2 we showed that real interest rates in the U.S. economy seem too low to reconcile actual consumption growth rates with evidence on individuals willingness to experience consumption fluctuations. If consumption growth rates were uncertain, would this explain or exacerbate the paradox?
Trending nowThis is a popular solution!
Chapter 17 Solutions
Microeconomic Theory
- In attempting to formulate a model of the passenger arrival data on cruise ships over time would a nonlinear (perhaps a multiplicative exponential) model be preferable to a linear model of cruise ship arrivals against time? What about in the case of the passenger arrivals by ferry against time?arrow_forwardEstimate the double-log (log linear) time trend model for log cruise ship arrivals against log time. Estimate a linear time trend model of cruise ship arrivals against time. Calculate the root mean square error between the predicted and actual value of cruise ship arrivals. Is the root mean square error greater for the double log non-linear time trend model or for the linear time trend model?arrow_forwardLiterature review about Phillip curve theory with reasonable arguments, knowledge, compare various point of viewsarrow_forward
- There are some simplifying assumptions in order to generate simple expressions. One of these assumptions is that r (interest rate) = ρ (rate at which household discounts future). Suppose we relaxed this assumption (i.e. allowed r to differ from ρ). Two results of the model are: i) The household keeps the expected value of consumption constant over time. ii) The household responds differently to permanent versus temporary income changes. Discuss the implications of allowing r to differ from ρ on each of these resultsarrow_forwardconsider the generalized Romer model where the fishing-out effect and the decreasing returns to research are allowed. suppose the number of researchers grows 5% each year and labor-augmenting technology level grows 1% each year. then, there exists an upper limit for the fishing-out effect in steady state. evaluate whether is true, false or uncertain and why?arrow_forwardDo you remember the Harrod-Domar model? Derive it and apply it to a numerical case where d=4%, s=35%, and gY=8% last year. If s is expected to rise to 45% next year, what will happen to gY?arrow_forward
- In the discussion of the life-cycle hypothesis, income is assumed to be constant during the period before retirement. For most people, however, income grows over their lifetimes. How does this growth in income influence the lifetime pattern of consumption and wealth accumulation shown in Figure 17-12 under the following conditions? Consumers can borrow, so their wealth can be negative. Consumers face borrowing constraints that prevent their wealth from falling below zero. Do you consider case (a) or case (b) to be more realistic? Why?arrow_forwardAt its meeting ending on 2 February 2022, The Bank of England (BOE) Monetary Policy Committee (MPC) voted to increase interest rate. Consumers react this rise in the interest: rate and adjust their choices between spending today and spending tomorrow. Suppose that there are two consumers: 1) John is a saver, and he decides to increase his savings after the BOE policy: 2) Lili is a saver, and she decides to decrease her savings after the BoE policy. Use the Life-Cycle Model (LCM) to answer the following questions. a) Draw a diagram to show the optimal choice for John. Explain your answer and your diagram in detail.arrow_forwardDiscuss how the theoretical CAPM model is made operational when going from the theory to the empirical practice.arrow_forward
- QUESTIONS 3 1. Explain the implication of the Ramsey model in terms of Pareto Efficiency Dynamic Efficiency 2. Assume that the economy is in a steady state and there is an unexpected permanent increase in the rate of depreciation δ. Using the appropriate diagram show: What is the best response to this change? Does consumption initially increase or decrease?arrow_forward“According to the Random-Walk Hypothesis of Consumption under Uncertainty, individuals don’t need to optimise their consumption over time since the consumption is totally unpredictable” True or False?arrow_forwardConsider the two-period household-maximization model discussed in class. The model is modified in order to look at applications including credit constraints, interest-rate markups, and taxation. A representative household lives for two periods and maximizes utility of consumption in period 1 and in period 2. The utility is represented by log(c) where c denotes consumption. Assuming no discounting between period 1 and period 2. The maximization problem for the representative household can be written as Max{logc1+logc2} c1+a1=y1-τ1+(1+r)a0 c2=y2-τ2+(1+r)a1 where y1 and y2 denote income levels in period 1 and period 2, τ1 and τ2 are taxes in the two periods, and a0 and a1 denote the assets of the households in each period. a0 is exogenously given. Assume the interest rate r = 0, and the government can borrow or save at the same interest rate so that its present-value budget constraint is given by where g1 and g2 are exogenous government expenditures in the two periods. (b). Show…arrow_forward
- Managerial Economics: Applications, Strategies an...EconomicsISBN:9781305506381Author:James R. McGuigan, R. Charles Moyer, Frederick H.deB. HarrisPublisher:Cengage Learning