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Consider an individual who enters adulthood and the labor force at age 18, expects to work 5 years at a real income of $10,000 per year, anticipates earning a real income of $40,000 per year from age 23 to 63, expects to retire with a $10,000 annual pension, and live until age 78. Suppose the interest rate is zero, and the individual seeks perfectly smooth consumption across his adult lifetime.
-If borrowing is precluded,then beginning at age 18,the individual will consume
A) $10,000 each year until age 23, then about $32,000 per year afterwards
B) $10,000 every year
C) all of his income as he receives it each year
D) $10,000 per year until age 23, then $25,000 per year afterwards
E) $25,000 every year

Question

Quizplus · Accepted Answer

The individual will consume $10,000 each year until age 23, then about $32,000 per year afterwards. This is because the individual wants to smooth consumption over his lifetime, and he has a total of $1,000,000 in lifetime income. If he consumes $10,000 per year for the first 5 years, he will have $950,000 left. If he then consumes $32,000 per year for the next 40 years, he will have $0 left at the end of his life.

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