Will Wisp will live for exactly two periods.His utility function is U(c₁, c₂)= c₁c₂, where c₁ is consumption in period 1 and c₂ is consumption in period 2.He will have no income in period 2.His income in period 1 is $80,000.If the interest rate rises from 10 to 12%: A)his savings will increase by 2% and his consumption in period 2 will increase. B)his savings will not change but his consumption in period 2 will increase by $800. C)his consumption in both periods will increase. D)his consumption in both periods will decrease. E)his consumption in period 1 will decrease by 12% and his consumption in period 2 will increase.

Question

Quizplus · Accepted Answer

As the interest rate rises, Will Wisp will save more because his marginal propensity to consume is less than 1. However, his savings will not increase by 2% because we are not given any information about how much he saves from his income in period 1. We only know that his income in period 1 is $80,000. 
Therefore, his savings will not change (since we don't have any specific information about his savings behavior), so option A is incorrect. 
Option C is also incorrect because his income in period 2 is zero, so he cannot consume more in both periods. 
Option D is also incorrect because we are told that his utility function is strictly increasing in consumption, so he would not choose to decrease his consumption in either period. 
Option E is incorrect because his consumption in period 1 is not affected by the interest rate. 
Therefore, the correct choice is B, that his savings will not change, but his consumption in period 2 will increase by $800.

Will Wisp Will Live for Exactly Two Periods