Molly has income $400 in period 1 and income $600 in period 2.Her utility function is c^a₁c¹^^a₂, where a  0.40 and the interest rate is 0.20.If her income in period 1 doubled and her income in period 2 stayed the same, her consumption in period 1 would

A) double.
B) increase by $160.
C) increase by $80.
D) stay constant.
E) increase by $400.

Question

julz colon buenacosa · Accepted Answer

Final Answer : B, Explanation :  Given the utility function and the parameters, when Molly's income in period 1 doubles from $400 to $800, and her income in period 2 remains at $600, the increase in her period 1 consumption is influenced by her propensity to consume out of current income (which is not directly given but implied to be less than 1) and the interest rate. The correct answer involves understanding how the increase in income affects consumption choices over the two periods, given the interest rate of 0.20. The specific increase amount, however, depends on the detailed structure of her utility function and how she optimally allocates the increased income between consumption in period 1 and savings for consumption in period 2, taking into account the interest rate. Without the explicit utility function form, we rely on general principles of intertemporal choice, which suggest that consumption in period 1 would increase but not double, as part of the additional income would be saved for future consumption. The choice that best fits these principles, given the options, is an increase by a specific amount, which is option B) increase by $160, assuming it reflects the correct calculation based on the given and implied parameters.

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