MGEB02H3 Lecture 9: Lecture 9.pdf

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Info: C = w(h-l) + I- T

Question:

1. Suppose both consumption good  and leisure are normal goods, discuss without any graphs what will happen to the household's choice if there is:

a) an increase in dividend income I

b) An increase in wage w

2. Suppose now only the consumption good is normal, and leisure is inferior. Repeat the last question's procedure.

Given the utility function:

U=lnc + l + lnc' + l'

and the budget constraint:

w(h-l) + w'(h-l')/(1+r) = c + c'/(1+r) where c = current consumption, c'= future consumption, l=current leisure, l'=future leisure, and r is the market interest rate. Suppose that the current wage, w=20 and the future wage w'=22.

What is the optimal value of current consumption, c? Show all steps.