Fisher model of consumption: Rocky and Bullwinkle both obey the two-period Fishe

Question

Fisher model of consumption: Rocky and Bullwinkle both obey the two-period Fisher model of consumption. (They took this class last quarter and both got As). Rocky earns $100 in the first period and $100 in the second period. Bullwinkle earns nothing the first period and $210 in the second period. Both of them can borrow or lend at the interest rate r.

a) If you observe both Rocky and Bullwinkle consuming $100 in the first period and $100 in the second period, what must the interest rate be?

b) If the interest rate rises, what will happen to Rocky's consumption in the first period? Is Rocky better off or worse off than before the interest rate rise?

c) What are two things that this model of consumption suggests we include in our consumption function that were not included in the simplest version of the Keynesian consumption function

Explanation / Answer

a) for rocky :: 100 + 100/(1+r) = 100 + 100 / (1+r)

for bullwinkle : 100 + 100/ (1+r) = 0 + 210 / (1+r)

solving 1+r = 110 / 100 = 1.1 ; r = 0.1 answer

b) for rocky ; C_1 + C_2 /( 1+r) = 100 + 100/(1+r)

=> C_1 = 100 + (100 - C_2) / (1+r) ;

clearly as r rises , C_1 will fall, he is worse off now

c) this model suggest two things :

1) include r ( rate of interest ) in model

2) include future conumption and income preference in model

both are missing from the keynesian model

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