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    Budget Constraints in a Two Period Model

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    Describe how the budget constraint of a house-hold in a two-period model is affected by each of the following changes. In each case, do you think the household is better off or worst off or is the answer ambiguous? If ambiguous, what does the answer depend on?

    A. Period 1 income is lower
    B. The interest rate is higher
    C. Period 2 income is lower, and the interest rate is lower.

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    Solution Preview

    a) If Period 1 is lower than Period 2, then the budget constraint will be lower in period 1 than it is in Period 2, since in period 1 the household will have less income to spend and in Period 2 it will have more income to spend. Thus the household is better off in period 2 than period 1.

    b) If interest rates increase, the answer is ambiguous. It depends on if the household is in debt or has ...

    Solution Summary

    The solution discusses budget constraints in a two period model.