Question

1. Ignacio has a utility function $U(c_1, c_2) = min(c_1, c_2)$ where $c_1$ and $c_2$ are his consumption in periods 1 and 2 respectively. Ignacio earns $147 in period 1 and $63 in period 2. He can borrow and save freely at an interest rate of 10%. (Hint: Leontief utility function is non-differentiable, you cannot calculate the MRS.) a. [5] If there is no inflation. calculate Ignacio's optimal level of consumption in each period. Will he save or borrow? b. [5] If the inflation rate is 5 percent, calculate Ignacio's optimal level of consumption in each period. How do his consumption choices compare to the ones you found in part (a)? Provide some intuition for this finding.

          1. Ignacio has a utility function $U(c_1, c_2) = min(c_1, c_2)$ where $c_1$ and $c_2$ are his consumption in periods 1 and 2 respectively. Ignacio earns $147 in period 1 and $63 in period 2. He can borrow and save freely at an interest rate of 10%.
(Hint: Leontief utility function is non-differentiable, you cannot calculate the MRS.)
a. [5] If there is no inflation. calculate Ignacio's optimal level of consumption in each period. Will he save or borrow?
b. [5] If the inflation rate is 5 percent, calculate Ignacio's optimal level of consumption in each period. How do his consumption choices compare to the ones you found in part (a)? Provide some intuition for this finding.

1. Ignacio has a utility function U(c1, c2) = min(c1, c2) where c1 and c2 are his consumption in periods 1 and 2 respectively. Ignacio earns 147 in period 1 and63 in period 2. He can borrow and save freely at an interest rate of 10%.
(Hint: Leontief utility function is non-differentiable, you cannot calculate the MRS.)
a. [5] If there is no inflation. calculate Ignacio's optimal level of consumption in each period. Will he save or borrow?
b. [5] If the inflation rate is 5 percent, calculate Ignacio's optimal level of consumption in each period. How do his consumption choices compare to the ones you found in part (a)? Provide some intuition for this finding.

Added by Terri M.

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