Hector's wealth is zero,he expects to work for another 45 years at a constant salary of ?$80 000 and live for another 60 years.If yearly taxes are $20 000 and Hector completely smooths consumption over his lifetime,his annual consumption is
A) $37 500.
B) $45 000.
C) $60 000.
D) $70 000.

Question

Quizplus · Accepted Answer

Since Hector expects to work for 45 years and live for 60, he will need to smooth his consumption over 105 years. His after-tax earnings will be $60,000 ($80,000 - $20,000 in taxes), so his total lifetime earnings will be equal to $60,000 x 45 = $2,700,000. To smooth his consumption over 105 years, Hector could consume $2,700,000/105 = $25,714.29 per year. However, this amount would not account for interest earned on savings or inflation. If we assume a 4% real interest rate and 2% inflation rate, then Hector could consume approximately $45,000 per year while smoothing his consumption over his lifetime. Therefore, the answer is B.

Hector's Wealth Is Zero,he Expects to Work for Another 45