Question

a) How do the pay-as-you-go and fully funded social security systems affect the equilibrium in the model with interrupted generations?

b) In the Fisher two-period model, if the consumer is a saver, consumption in periods one and two are normal goods, and the income effect of an increase in interest rate is greater than the substitution effect, then saving:

A) will increase.

2. will decrease.
3. will not change.
4. may either increase or decrease.

Answer 1

Answer A)

The pay-as-you-go and fully funded social security systems affect the equilibrium in the model positively. with interrupted generation. As the above scheme are with the motive to improve the elderly health of individuals. Elderly health refer to the life after retirement. And contribution under this scheme make the interrupted generations better education and health which will become a factor for prosperity of economy, as quality of demography improves.

Answer B)

Option B "will decrease" is the answer where increase in interest rate will lead to the increase in consumption of the consumer.

Two Period Consumption Model

This model given by the fishers as stated in the question under which we can study the consumer behaviour for maximizing its level of satisfaction from present consumption and from future consumption. So it is stated in a mathematical expression that how change in behaviour of consumer takes place for the achivement of maximum level of satisfaction.

The above question is related to the response of consumer when increase in interest rate is greater than the substitution effect and here we particularly focused on the intensity of saving of consumer. So the response of consumer negative in this context because income effect positively in contrast to substitution effect. An individuals have strong reaction to increase in purchasing power. Hence current consumption of the saver increases and their will reduction in savings.