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By how much do consumption and saving change today

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Question: Financial wealth and consumption: Consider the neoclassical consumption model with log utility and ß = 1. Suppose an individual begins with $10,000 in stocks and $30,000 of equity in her house, so that financial assets are ftoday = $40,000. Suppose her labor income stream is $50,000, both today and in the future, and suppose the real interest rate is zero.

(a) What is ctoday and cfuture? How much does the consumer save today?

(b) Suppose the stock market booms, doubling in value. By how much do consumption and saving change today?

(c) Alternatively, suppose housing prices rise so that the individual's equity in her house rises to $50,000. Now what happens to consumption and saving today?

(d) Discuss briefly how this exercise is related to the state of the U.S. economy around 2007.

Reference no: EM131634645

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