Question

8.) Consider two workers with identical preferences, Phil and Bill. Both workers have the same life cycle wage path in that they face the same wage at every age, and they know what their future wages will be. Leisure and consumption are both normal goods.

a) Compare the life cycle path of hours of work between the two workers if Bill receives a one- time, unexpected inheritance at the age of 35.

b) Compare the life cycle path of hours of work between the two workers if Bill had always known he would receive (and, in fact, does receive) a one-time inheritance at the age of 35.

Answer 1

Ans:-

A)

Because the workers have the same life cycle wage path and the same preferences, they will have
the same life cycle path of hours of work up to the unexpected event. An inheritance provides an
income effect for Bill with no substitution effect, and thus, he will work fewer hours (or at least not
more hours) than Phil from the age of 35 forward.

B)

In this case, because the inheritance is fully anticipated, and because it offers the same income
effect with no substitution effect, Bill will work fewer hours (or at least not more hours) than Phil
over their entire work lives.