Mr. Free has $100 income this year and zero income next year. The market interest rate is 10 percent per year. If Mr. Free consumes $30 this year and invests the rest in the market, what will be his consumption next year?
A)$50
B)$55
C)$77
D)$100

Question

Quizplus · Accepted Answer

Mr. Free will invest $70 in the market at the interest rate of 10 percent, so he will have:

$70 x 1.1 = $77

In the second year, Mr. Free will have no income and will only be able to consume the return from his investment, which is $77. Therefore, his consumption next year will be $77.

Choice A, $50, is incorrect because it assumes that Mr. Free will consume $20 less in the second year. However, Mr. Free will have no income in the second year and will need to consume the return from his investment.

Choice B, $55, is incorrect because it assumes that Mr. Free will consume the same amount in both years, even though he will have no income in the second year.

Choice D, $100, is incorrect because it assumes that Mr. Free will consume his entire income in the first year, even though he could invest some of it for a higher return in the future.

Mr Free Has $100 Income This Year and Zero Income