Unit 2 Practice Problem #5

Q:

I was doing the practice problems for unit 2 that are posted on the course website, and I ran into some confusion regarding interest rates and budget constraints. For #5, the budget constraint has consumption in the first year on the x-axis and consumption in the second year on the y-axis, as expected. However, the consumption in the second year does not account for the money that will additionally be earned in that year; in other words, the maximum consumption is 31500, from the money saved from the first year, instead of 30000 + 31500, using the money saved from the first year in addition to the money gained in the second year. However, as I recall, there was a similar problem in PS6 that followed the second way. What should I do, should this problem arise on the exam?

A:

You are right about the practice problem. As far as the exam goes, your best bet is to just state any assumptions that you make. In this case, I would say something like "I am assuming that I get $30,000 both this year and next year and I can't borrow any money".

Also, note that the way the practice problems are labeled by unit corresponds to what unit they were in last year, not this year. Obviously, budget constraints and indifference curves were not covered in unit 2 this year for example!