4.Ali inherits $10,000 from his great-great aunt in 2008. His great-great aunt's will requires that Ali...

4.Ali inherits $10,000 from his great-great aunt in 2008. His great-great aunt's will requires that Ali spend the money before December 31, 2009. He has two spending options: He can either spend the amount in 2008 or in 2009. Suppose this is Ali's only source of income and the interest rate on loans or savings is 10 percent. (a) How much could Ali spend in 2008 if he only consumes in 2008? How much could Ali spend in 2009 if he only consumes in 2009? (b) What is the opportunity cost of consuming $1.00 in 2008 in terms of forgone consumption in 2009? Draw Ali's budget constraint and optimal consumption bundle, considering that the spending in 2008 is measured along the horizontal axis. (c) Ali decides to spend $6,000 in 2008 and $4,400 in 2009. Show this optimal consumption bundle using a budget constraint and indifference curve diagram.

Solutions

Expert Solution

Q. (a). Answer :-

Year of spending (expenditure year)	Year of consumption	*Amount of spending by Ali*
2008	2008	10,000
2009	2009	11,000 (Note 1)

(Note 1) :- Amount of spending by Ali in Year 2009 = 10000 * (1 + 0.10)

= 10000 * 1.10

= $ 11,000.

Conclusion :- Ali will spend $ 10000 if he spend and consume in year 2008.

Ali will spend $ 11000 if he spend and consume in year 2009.

Q. (b). Answer :- Opportunity cost will be the value of second (best) alternative foregone. Accordingly, Opportunity cost (in the given question) will be $ 1.10 (1 + 0.10) on account of consumption of $ 1.00 in the year 2008.

Rahul Sunny answered 1 year ago

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