Consider the two-period intertemporal model that we studied in class.
(a) (5 marks) Discuss the similarities and differences between the drivers of consumption predicted by this model compared to those suggested by the traditional KeynesianconsumptionfunctionC=C(Y âT).
(b) (10 marks) Explain why this model predicts that consumption in the present and future will increase in response to either a rise in current income, or, a rise in future income. What happens to savings in each case?
(c) (15 marks) On a C1 vs. C2 diagram, sketch an indifference curve and budget constraint showing the optimal choice for a borrower. Now show the impact of an increase in the real interest rate r on the borrower, sketching two different cases: (i) where the increase in r results in a rise in period 2 consumption, and (ii) where the increase in r results in a fall in period two consumption. How can the model account for these two different cases? Discuss, what assumption must hold in each case.