Question

A consumer has nonhuman wealth equal to $100,000. She earns $40,000 this year and expects her salary to increase by 5% in real terms each year for the following two years. She will then retire. The real interest rate is equal to 0% and is expected to remain at 0% in the future. Labor income is taxed at a rate of 25%

This consumer's human wealth is $ (Round your response to the nearest whole number.)

Her total wealth is $ (Round your response to the neareskwhole number.)

If she expects to live for seven more years after retiring and wants her consumption to remain the same (in real terms) every year from now on, how much can she consume this year?

She can consume $ this year. (Round your response to two decimal places.)

Answer 1

Salary at end of year 1 =$40,000

Wealth after taxation (w1) = 40,000(1 - 25/100) = $30,000

Salary at end of year 2 = 40000(1 + 5/100) = $42,000

Wealth after taxation (w2) = 42,000(1 - 0.25) =$31,500

At end of year 3 = 40000 (1+5/100)² = $44,100

Wealth after taxation (w3) = 44100(1 - .25) = $33,075

a)

Human wealth = w1 + w2 + w3 = $94,575

b)

Total wealth = Human wealth + Nonhuman wealth

= 94,575 + 100,000

= $194,575

c)

Total living years including now = 3 + 7 = 10

So, for consumption to be equal throughout her lifetime, she should be spending her total wealth equally.

So, wealth she can consume

= Total wealth/Total living years

= 194,575/10

= $19,457.5

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