Suppose that Molly from Problem 2 had an income of $400 in period 1 and an income of $690 in period 2. Suppose that her utility function were c^a₁c¹^-^a₂, where a = 0.80 and the interest rate were 15%. If her income in period 1 doubled and her income in period 2 stayed the same, her consumption in period 1 would A) stay constant. B) increase by $320. C) increase by $160. D) double. E) increase by $400.

Question

Quizplus · Accepted Answer

Doubling Molly's income in period 1 to $800 would increase her budget for period 1, causing her to increase her consumption in period 1. Using the utility function, we can find the optimal values of cS1 and cS2 for both scenarios, and compare them. Solving for the optimal consumption levels, we find that Molly's optimal consumption in period 1 would increase from $464.00 to $784.00, an increase of $320.00. Therefore, the answer is (B) increase by $320.

Suppose That Molly from Problem 2 Had an Income of $400