Microeconomics 2nd Edition by Douglas Bernheim

Exercise 1

Garfield cares only about the amount of lasagna he eats this year and the amount of lasagna he eats next year. We will use L 0 to stand for lasagna this year and L 1 to stand for lasagna next year. His preferences correspond to the utility function U ( L ­ 0 , L 1 ) = ( L 0 Z )( L 1 Z ), where Z is some fixed number. Suppose he earns $500 this year and nothing next year. Lasagna costs $10 per kilogram in both years and the interest rate (expressed as a decimal) is R. Find a formula showing how much Garfield will save as a function of the interest rate (as well as Z ). When the interest rate rises, does Garfield save more or less How does the answer depend upon Z