Ali obeys the two-periodFisher intertemporal model of consumption. Ali earns Rs.

Question

Ali obeys the two-periodFisher intertemporal model of consumption. Ali

earns Rs. 200 in thefirst period and Rs. 400 in the second period.

A. If Ali consumes Rs.280 in the first period and Rs. 300 in thesecond

period, what is theinterest rate?

B. Now if Ali'sconsumption changes in such a way that heconsumes

Rs. 300 in the firstperiod and Rs.280 in the second period, then

calculate the newinterest rate?

C. Suppose there is anincrease in Ali’s income in first period, whatwill

be its impact on hisconsumption in both periods and on budget

constraint? (Note:Ali’s consumption in both periods is onnormal

goods)

(Marks = 6+6+3)

Explanation / Answer

a)

First period

Y1=200

C1=300

Second period

Y2=400

C2=280

S= Y1– C1

S = 200–300

C2 = (1+r) S + Y2

280 = – 100 – 100r + 400

100r = 300 – 280

         = 20

r = 20/100

= 20%

b)In the first period      Y­­1=200                      C1=280           

In the second period     Y2=400                      C2=300

S= Y­­1- C1

S= 200-280=-80

C2= (1+r) S+ Y2

300= (1+r)-80 + 400

300 = -80-80r+400

80r =400-80-300 = 20

r= 20/80=1/4=.25

So the interest rate is 25%

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