Suppose that Molly 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

Given the utility function and the parameters provided, when Molly's income in period 1 doubles from $400 to $800, and her income in period 2 remains the same at $690, the increase in her consumption in period 1 can be calculated considering the effect of the interest rate and her propensity to consume out of her current income. The increase in consumption is not directly proportional to the increase in income due to the intertemporal choice model, which involves saving and consumption decisions over two periods influenced by the interest rate. The correct answer involves calculating the additional amount available for consumption in period 1 due to the income increase, taking into account the propensity to consume (a=0.80) and the effect of the interest rate (15%). The specific increase amount indicates that the consumption pattern changes in a way that reflects both the immediate increase in income and the decision on how much of that increase to consume now versus save for the future, leading to an increase by $320.

Suppose That Molly Had an Income of $400 in Period