In the neoclassical consumption model with log utility functions for current and future consumption, an increase...

In the neoclassical consumption model with log utility functions for current and future consumption, an increase in the interest rate will increase the growth rate of consumption. true or false and why

Expert Solution

A ) False

consumption won't grow as a result of rise in interest rate. . Total wealth depends on Interest rate because it includes the present discounted value of labour . Higher interest rate will reduce theis present value in general and it will therefore reduce consumption in the case of log utility. This force is called wealth effect of a higher interest rate because it works through the total wealth term.

Note :changes in interest rates often involves substitution effect and income effect. In the case of log utility these effects offset each other . Substitution effect of a higher interest rate is that current consumption is more expensive ( because savings will lead to even more consumption in the future). So the consumers will tend to reduce consumption today. The income effect says that - the consumers are now richer- because current saving leads to more income in future -which makes them wants to consume more today. In general,higher interest rates can either rise or lower current consumption because these effects work in opposite directions.

Rahul Sunny answered 2 years ago

Suppose that individuals become more optimistic about their future incomes, and increase consumption at their current...

Suppose that individuals become more optimistic about their future incomes, and increase consumption at their current levels of disposable income. Use the Romer model to explain the short-run (immediate) and long-run effects of this law on inflation, output, the real interest rate, consumption, and investment.

Assess the importance of the neoclassical consumption model for modern macroeconomics and explain the intuitions behind...

Assess the importance of the neoclassical consumption model for modern macroeconomics and explain the intuitions behind the two fundamental equations of this type of model. (i.e. Euler Equation and Intertemporal Budget constraint)

show the effect of a decrease in the interest on current and future consumption for a...

show the effect of a decrease in the interest on current and future consumption for a lender and borrower. What is the overall effect of a decrease in the interest rate on current consumption?

Suppose a consumer who has a marginal rate of substitution of current consumption for future consumption...

Suppose a consumer who has a marginal rate of substitution of current consumption for future consumption that is a constant, b. Determine how this consumer’s choice of current consumption, future consumption, and savings depends on the market real interest rate r, and taxes and income in the current and future periods. Show this in diagrams.

Consider the two-period Neoclassical consumption model seen in class. Suppose that income is measured in dollars....

Consider the two-period Neoclassical consumption model seen in class. Suppose that income is measured in dollars. Let the utility function take the logarithmic form U(C)=ln C, and the representative consumer maximize her lifetime utility subject to her budget constraint. Suppose that income in period 1 is $50,000, income in period 2 is $30,000, ?=1 and ?=5%. Do you think that the consumption profile of the agent in this numerical example is going to be smoother than her income? If so,...

Consider a conventional neoclassical economic model, where workers value both leisure and consumption and are willing...

Consider a conventional neoclassical economic model, where workers value both leisure and consumption and are willing to make entirely conventional tradeoffs between those two goals. Output is produced via a conventional production function with diminishing returns to labor. For simplicity, entirely ignore the role of capital. If purely wasteful government purchases increase, and the government purchases are financed via lump-sum taxes, what will be the effects of this increase in the size of government on: Real GDP Real wage (per...

Differences between log linear model and generalized log linear model.

: Suppose that the representative consumer’s preferences over current consumption (C) and future consumption (C 0...

: Suppose that the representative consumer’s preferences over current consumption (C) and future consumption (C 0 ) are given by the following utility function U(C, C0 ) = CC0β The market real interest rate is denoted by r and β > 0. 1. Write down the consumers’ budget constraint for the current and future period. 2. Using the equations in part (1), obtain the inter-temporal budget constraint. 3. Set up the consumer’s optimization problem using the Lagrangian approach. Next, derive...

Consider a model in which individuals live for two periods and have utility functions of the...

Consider a model in which individuals live for two periods and have utility functions of the form ? = ??(?1) + .5??(?2). They earn income of $10,000 in the first period and save S to finance consumption in the second period. The interest rate, r, is 20. a. Set up the individual’s lifetime utility maximization problem. Solve for the optimal C1, C2, and S. (Hint: ????1,?2 = −.5?2/?1 and the budget line is given by C2= (10,000-C1)(1+r) hence the slope...

Recall the basic model of consumption choice. There are two periods: present and future. Assume households...

Recall the basic model of consumption choice. There are two periods: present and future. Assume households have the following lifetime utility: u(c) + βu(c f ) where u(c) = √ c, the discount rate β < 1 (i.e., the rate at which households discount utility from future consumption). Assume also that households start with no initial wealth, a = 0, but receive income today, y, and income tomorrow, y f . The interest rate, r, is equal to 4%. Assume...

Question