Chapter13SolutionstotheProblemsintheTextbook:ConceptualProblems:1.a.Accordingtothelife-cycletheoryofconsumption,peopletrytomaintainafairlystableconsumptionpathovertheirlifetime.Individualssaveduringtheirworkingyearssotheycankeepupthesameconsumptionstreamaftertheyretire.Thisimpliesthatwealthincreasessteadilyuntilretirementwhileconsumptionremainsstable.Weshouldthereforeexpecttheratioofconsumptiontoaccumulatedsaving(wealth)todecreaseovertimeuptoretirement.1.b.Afterretirement,wealthisuseduptofinanceconsumptionduringtheremainingyears.Thereforetheratioofconsumptiontoaccumulatedsaving(wealth)increasesagainafterretirement,eventuallyapproaching1.2.a.Supposethatyouandyourneighborbothworkthesamenumberofyearsuntilretirementandyoubothhavethesameannualincome.Ifyourneighborisinbadhealthanddoesnotexpecttoliveaslongasyoudo,shewillexpecttohavefewerretirementyearsinwhichtouseaccumulatedwealthtofinanceasteadyconsumptionstream.Yourneighbor'sgoalforretirementsavingwillnotbeashighasyours,andcomparedtoyou,shewillhaveahigherlevelofconsumptionoverherworkingyears.Sinceplannedannualconsumption(C)isdeterminedbythenumberofworkingyears(WL),thenumberofyearstolive(NL),andincomefromlabor(YL),wegettheequation:C=[(WL)/(NL)](YL).WLandYLarethesameforyouandyourneighbor,butNLissmallerforyourneighbor.Thereforeyouwillhavealowerlevelofconsumption(C).(Note:Studentsmaycomeupwithavarietyofdifferentanswers.Forone,yourneighbor,whoisinbadhealth,currentlyhasmuchlargermedicalbillsthanyoudo.Thereforeshemaynotbeabletosaveasmuchforretirement,evenifshemightexpecttoliveaslongasyou.Ontheotherhand,shemaynothavelargemedicalbillsnow,butexpectsthemlater,asshegetsolder.Thismayinducehertosavemorenow.Whilesuchargumentsarevalid,instructorsshouldpointoutthattheanswershouldberelatedtothelife-cycletheory.)2.b.IfweassumeforsimplicitythattherateofreturnonSocialSecurityisthesameastherateofreturnonprivatesaving,thentheintroductionofaSocialSecuritysystembasedonatrustfundshouldnothaveanyeffectonyourlevelofconsumption.SocialSecuritymayb...
