Molly has income $200 in period 1 and income $920 in period 2.Her utility function is c^a₁c¹^^a₂, where a  0.80 and the interest rate is 0.15.If her income in period 1 doubled and her income in period 2 stayed the same, her consumption in period 1 would

A) increase by $160.
B) double.
C) increase by $80.
D) stay constant.
E) increase by $200.

Question

Yesenia Ramos · Accepted Answer

Final Answer : A, Explanation :  Given the utility function and the parameters provided, when Molly's income in period 1 doubles from $200 to $400, and her income in period 2 remains the same at $920, her consumption in period 1 increases due to the higher income available for consumption and saving. The increase in consumption is not directly proportional to her income because her consumption choices depend on her utility function, which involves both her current and future consumption preferences, as well as the interest rate. However, given the specific increase in income and the parameters provided, the closest approximation without detailed calculations (since the utility function is not clearly defined) suggests that her consumption in period 1 would increase by $160, assuming she allocates part of her increased income to consumption and part to savings, influenced by her time preference rate (a = 0.80) and the interest rate (0.15).

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