Modiglianis life cycle hypothesis Suppose that your lifetime

Modigliani’s life cycle hypothesis: Suppose that your lifetime is divided up into three periods: t = 1 is youth, t = 2 is middle age, t = 3 is old age. Your income in each period is Y1 = 30, Y2 = 50, Y3 = 10. In addition, you are born with initial wealth W = 10.

(a) If you follow Modigliani’s life cycle hypothesis, what will be your consumption in each period C1, C2, and C3?

(b) How does your consumption in period 1 change C1 with a temporary increase of 10 units in your income in period 2 to Y2 = 60 (Y1 and Y3 stay the same)?

(c) How does your consumption in period 1 change C1 with a permanent increase of 10 units of income in each period such that Y1 = 40, Y2 = 60, and Y3 = 20?

Solution

(a) As per the given data, I have classified the data individually of Age, Income. So, based on this data we need to find out the consumption of C1, C2 & C3?

(b): We know most of the responsibilities have at the middle age. So, the person has a chance to get a more income by doing an extra work or additional work. The responsibilities very less or it will not be had for Youth and Old age people.

(c): when it increases the 10 units for Youth, Middle & Old age persons than the calculation of consumption like as below: