Assume That Jeannie Drago Is Trying to Allocate Her Consumption $C _ { 1 }$

Essay

Assume that Jeannie Drago is trying to allocate her consumption over two periods of life: work and retirement. Each period is to last 20 years. To simplify, assume that all income comes at time t₁ in the middle of 20 years of work, and all expenditures come at either t₁ or t₂, 20 years later. Jeannie's budget constraint is C₁ + C₂/(1 + r/100) = Y₁ + Y₂/(1 + r/100), where the real interest rate r is 100 percent (approximately 3.5 percent per year over 20 years). Jeannie's preferences are to have equal consumption each period. a. What are $C _ { 1 }$ and $C _ { 2 }$ if $Y _ { 1 } = 1$ million and $Y _ { 2 } = 0$ ?
b. What are $C _ { 1 }$ and $C _ { 2 }$ if $Y _ { 1 } = 0$ and $Y _ { 2 } = 1$ million (reflecting, for example, an individual who plans to come into a large inheritance late in life)? Do these answers depend on Jeannie's being able to borrow against the inheritance?