Janet Knows That She Will Ultimately Face Retirement

Essay

Janet knows that she will ultimately face retirement.Assume that Janet will experience two periods in her life, one in which she works and earns income, and one in which she is retired and earns no income.Janet can earn $250 000 during her work period and nothing in her retirement period.She must both save and consume in her work period, and can earn 10 per cent interest on her savings.
a.Use a graph to demonstrate Janet's budget constraint.
b.On your graph, show Janet at an optimal level of consumption in the work period equal to
$150 000.What is the implied optimal level of consumption in her retirement period?
c.Now, using your graph from part b above, demonstrate how Janet will be affected by an increase in the interest rate on savings to 15 per cent.Discuss the role of income and substitution effects in determining whether Janet will increase or decrease her savings in the work period.