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Suppose a household can expect to earn $2 M during its working life. Its problem is to allocate this income between present (working life) consumption (Cp) and saving for future consumption during retirement (Cf). Assume that the real after-tax interest rate between the two periods is 50%, and that both Cp and Cf are normal goods.
(a) What is equation of the household’s budget line? Illustrate in a diagram being sure to identify the horizontal (Cp) and vertical (Cf) intercepts. What is the relative price (opportunity cost) of Cp? Provide detailed explanation
(b) Suppose (when faced with this budget line) that the household would prefer to have equal consumption in both periods. How much does it consume in the present? How much does it save? How much does it consume in the future? Illustrate this choice with an indifference curve and identify the level of saving in your diagram. Provide detailed explanation
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