Mandy has an income of $800 in period 1 and will have an income of $500 in period 2. Her utility function is U(c₁, c₂) = c^0.80₁c^0.20₂, where c₁ is her consumption in period 1 and c₂ is her consumption in period 2. The interest rate is .25. If she unexpectedly won a lottery which pays its prize in period 2 so that her income in period 2 would be $1,000 and her income in period 1 would remain $800, then her consumption in period 1 would

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Quizplus · Accepted Answer

The increase in future income allows Mandy to borrow against it, increasing her period 1 consumption by the present value of the additional $500, which is $500 / (1 + 0.25) = $400.

Mandy Has an Income of $800 in Period 1 and Will