1) Suppose you will earn $25,000 this year and $30,000 next year.  If the interest rate is 10%, what is the maximum amount you could spend on consumption next year, assuming that you could afford to save all your income this year (for example, maybe you're living with your parents this year and they are paying for all your basic living expenses).

2) Suppose you will earn $30,000 next year and the interest rate is 5%.  If you plan to use next year's income to pay back a bank loan, what is the maximum loan you can obtain from a bank?

3) Write down the equation for the Consumption/Savings Constraint.  Explain the equation.

4) Graph the Consumption/Savings Constraint.

5) Use a graph to show how the Consumption/Savings Model determines a consumer's allocation of consumption expenditures across two time periods.

6) Use a graph to conduct a sensitivity analysis on the Consumption/Savings Model with respect to a change in the interest rate parameter, r.

7)  Describe the two effects of a change in the interest rate on a consumer's savings behavior.

8) The Savings Supply Curve is also known as the _________________.

Multiple Choice

2a) If the interest rate, r, increases, then consumers can earn the same interest from fewer dollars of savings, so consumers decide to decrease their savings in order to enjoy more consumption spending today. This is called the _____________ of an interest rate increase. a) substitution effect, b) consumption-savings constraint, c) income effect, d) demand curve effect

2b) If the interest rate, r, increases, then consumers earn more interest on each dollar of savings, and this encourages them to save more in order to enjoy more consumption spending in the future. This is called the _____________ of an interest rate increase. a) demand curve effect, b) consumption-savings constraint, c) income effect, d) substitution effect

3a) Suppose Austin Powers, undercover agent and “International Man of Mystery,” will receive I₀ = $200,000 in income in the current, shagadellic time period, and I₁ = $350,000 in income in the next time period (Oh, behave!). Suppose we consider these two time periods only, and suppose the interest rate for either saving or borrowing from the Bank of (sinister music) Dr. EEEE-VILLLLL is 8% (equivalent to 0.08). If Austin decides to be a "little squirrel" and save all his nuts (current income) for the future (in case he loses his mojo), what is his maximum future consumption spending level, c₁max?

a)  $550,000, b) $509,259, c) $378,000, d) $566,000

3b) On the other hand, if Austin decides to "live fast and die young" (Groovy, baby!, Yeah!) in the current, shagadellic period and save nothing for the future; what is the maximum loan he can get from a bank?   a) $324,074 b) $185,185, c) $509,259, d) $378,000