Question

In: Finance

A) A worker named Hastings lives for two periods (year 0 and year 1) and has...

A) A worker named Hastings lives for two periods (year 0 and year 1) and has to choose his optimal level of education. He has two choices. He can choose to go to school during year 0, in which case he has no earnings during that period; however, in year 1 he earns $220. Alternatively, he can choose not to go to school, in which case he earns $110 in both periods.

Part1. What is Hastings’ present discounted value (PDV) of lifetime earnings if he chooses not to go to school? Assume a discount rate of 10%.

Part2. What is Hastings’ present discounted value of lifetime earnings if he chooses to go to school in year 0? Assume a discount rate of 10%.

Part3. Given your answers to (1) and (2), should Hastings choose to go to school or not? Why?

Part4. Hastings’ sister Patience also lives 2 periods and if she decides not to go to school she also makes $110 in each period. However, if she decides to go to school, she can work part time and earn $50 in year 0 and then earn $220 in year 1. Patience has a discount rate of 0%. Should Patience attend school or not? Show your work

Solutions

Expert Solution

He lives only for year 0 and 1. So calcultion will be made for 2 years       
(a) If not to go to school, Earnings are $110 in year 0 and year 1      
Discount rate (i)=    10%  
So Present value = Sum of (Future Value/(1+i)^n)      
110/(1+10%)^0 + 110/(1+10%)^1      
210      
      
So present discounted value (PDV) of lifetime earnings if he chooses not to go to school is   $210.00  
      
(b) If go to school, Earnings are $220 in year 1      
Discount rate (i)=    10%  
So Present value = Sum of (Future Value/(1+i)^n)      
220/(1+10%)^1      
200      
      
So present discounted value (PDV) of lifetime earnings if he chooses to go to school is   $200.00  
      
(3) Present value of earnings is more if he chooses not to go to school.       
So he should choose not to go to school.      
      
(4) Patience earnings if not to go school is    $110  
Discount rate (i)=   0%  
      
So Present value = Sum of (Future Value/(1+i)^n)      
110/(1+0%)^0 + 110/(1+0%)^1      
      
220      
      
If go to school, Earnings are $50 in year 0 and $220 in year 1      
So Present value=      
50/(1+0%)^0 + 220/(1+0%)^1      
270      
      
Present value is more in case of go to school.       
So she should choose to go to school      
      
      
(Please thumbs up or post comments if any query)

jeff jeffy answered 1 month ago
Next > < Previous

Related Solutions

Assume a consumer lives for two periods. His income and consumption in the two periods are...
Assume a consumer lives for two periods. His income and consumption in the two periods are Y1 and C1, and Y2 and C2 respectively. Ignore price level changes and further assume that this consumer saves income (S) in the first period and this saving earns interest. With consumption in two periods being constrained by income in the two periods derive the intertemporal budget constraint.
An Individual lives for two periods, 1 and 2. In the first he works and earn...
An Individual lives for two periods, 1 and 2. In the first he works and earn an income of M. In the second he is retired and has no income. His/her life time utility is a function of how much he consumes in the two periods. C1 denotes consumption in period 1 and C2 consumption in period 2. (Hint: If you want to, you can view and treat C1 and C2 as any pair of “goods”, e.g. good x and...
An Individual lives for two periods, 1 and 2. In the first he works and earn...
An Individual lives for two periods, 1 and 2. In the first he works and earn an income of M. In the second he is retired and has no income. His/her life time utility is a function of how much he consumes in the two periods. C1 denotes consumption in period 1 and C2 consumption in period 2. (Hint: If you want to, you can view and treat C1 and C2 as any pair of “goods”, e.g. good x and...
An Individual lives for two periods, 1 and 2. In the first he works and earn...
An Individual lives for two periods, 1 and 2. In the first he works and earn an income of M. In the second he is retired and has no income. His/her life time utility is a function of how much he consumes in the two periods. C1 denotes consumption in period 1 and C2 consumption in period 2. (Hint: If you want to, you can view and treat C1 and C2 as any pair of “goods”, e.g. good x and...
Consider an individual who lives for two periods t = 1, 2. Suppose she is in...
Consider an individual who lives for two periods t = 1, 2. Suppose she is in debt and, given an interest rate r, she optimally decides to consume (C1;C2). Now, imagine that the interest rate r falls. What do you expect to happen to her optimal consumption in the two periods? Explain your answer referring to income and substitution e§ects, to the budget constraints, and the Euler equation.
Romeo lives two periods, and he earns m1 =$10,000 in period 1 and m2 =$12,000 in...
Romeo lives two periods, and he earns m1 =$10,000 in period 1 and m2 =$12,000 in period 2, respectively. His utility function is u(c1; c2) = c1*c2. Answer the following questions. (a) Suppose that market interest rate is 50% (r = 0:5). Write down Romeo‘s budget constraint. How much does he save or borrow in period 1? Calculate. Explain your answer. Draw a diagram, too. (b) The interest rate goes down from 50% to 25%. What happens his saving or...
Ramesh lives two periods. His earnings in the present are 100; in the future they are...
Ramesh lives two periods. His earnings in the present are 100; in the future they are 75.6. The interest rate is 8 percent. (a) Suppose that Ramesh's earnings are subject to a 25 percent tax. Suppose also that interest earnings are taxed at the same rate and interest paid is tax deductible. Using our life-cycle model, show that this tax generates an excess burden. (b) Suppose now that interest payments are not tax deductible. Does this tax generate an excess...
1 Roving bandit vs. stationary bandit Assume that there are two periods, 0 and 1. The...
1 Roving bandit vs. stationary bandit Assume that there are two periods, 0 and 1. The first period output from the economy is 1, an autocrat can tax it with a tax rate, 0 ≤ t ≤ 1. a. Denote the tax revenue as c0. How much is it in terms of t? How much of the output is left after tax, i.e., how much is 1 − c0 in terms of t? b. Assume that the second-period output from...
A.  Assume Charlie lives for two periods and must choose between two options.  Option 1:  Do not attend school...
A.  Assume Charlie lives for two periods and must choose between two options.  Option 1:  Do not attend school at all and work in both periods at a salary of $20,000 per period.  Option 2:  Attend school in the first period incurring $5,000 in direct schooling costs, then in the second period work at a salary of $45,000.  Assume the discount rate between periods is 5 %.  Which option will Charlie choose to pursue? B.  State whether the below is True or False, then explain your reasoning. When...
Consider an agent who lives two periods. He is unemployed at the beginning of the first...
Consider an agent who lives two periods. He is unemployed at the beginning of the first period and has a wage offer of w. If he accepts the wage offer w, he will work at that wage in both periods. If he rejects the o§er, he receives unemployment benefit of $4 this period and he gets to draw a new wage offer next period. There are only two possible offers with equal probability next period: one wage offer at $8,...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT