Describe how the budget constraint of a household in a two-period model is affected by each of the...

Question

Describe how the budget constraint of a household in a two-period model is affected by each of the following changes. In each case, do you think that the household is better off or worse off, or is the answer ambigous? If ambigous, 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.

David · Accepted Answer

Describe how the budget constraint of a household in a two-period model is affected by 
each of the following changes. In each case, do you think that the household is better off or 
worse off, or is the answer ambigous? If ambigous, what does the answer depend on? 
a. Period 1 income is lower. 
Answer: 
The budget constraint of the household in the two period models can be given as: 
Y1 + Y2/(1+r) = C1 + C2/(1+r)      ……………………… (1) 
When period 1 income is lowered (from Y1 to Y1”), there will be decline in households 
lifetime income, and therefore household would be able to consume less in the two periods. 
In this case, budget constraint of the household would shift inward or leftward, implying 
that household is able to consume less in both the periods.

Describe how the budget constraint of a household in a two-period model is affected by each of the following changes. In each case, do you think that the household is better off or worse off, or is...

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