Mr. O. B. Kandle will only live for two periods. In the first period he will earn $50,000. In the second period he will retire and live on his savings. His utility function is U (c1, c2) = c1c2, where c1 is consumption in period 1 and c2 is consumption in period 2. He can borrow and lend at the interest rate r = .10.
(a) If the interest rate rises, will his period-1 consumption increase, decrease, or stay the same?
(b) Would an increase in the interest rate make him consume more or less in the second period?
(c) If Mr. Kandle’s income is zero in period 1, and $ 55,000 in period 2, would an increase in the interest rate make him consume more, less, or the same amount in period 1?