question archive Albert and Franco both follow the life-cycle hypothesis: they smooth consumption as much as possible
Albert and Franco both follow the life-cycle hypothesis: they smooth consumption as much as possible
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Albert and Franco both follow the life-cycle hypothesis: they smooth consumption as much as possible. They each live for five periods, the last two of which are retirement. Here are their incomes earned during each period:
| Period | Albert | Franco |
| 1 | $100,000 | $40,000 |
| 2 | 100,000 | 100,000 |
| 3 | 100,000 | 160,000 |
| 4 | 0 | 0 |
| 5 | 0 | 0 |
To keep things simple, assume that the interest rate is zero for both saving and borrowing and that the life span is perfectly predictable.
a. For each individual, compute consumption and saving in each period of life.
b. Compute each individual’s wealth (i.e., their accumulated saving) at the beginning of each period, including period six.
c. Graph consumption, income, and wealth for each of them, with the period on the horizontal axis.
d. Now suppose consumers cannot borrow, so wealth cannot be negative. How does that change your answers? Draw a new graph for part (c) if necessary.
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