c1,c2 Budget Constraint
pwatumull
Which of these is the correct budget constraint?
(1+r)c1+(1+pi)c2=(1+r)c2+m2
vs
(1+rho)c1+c2=(1+rho)c2+m2
When doing problems like number 1 on Midterm Spring 2015 I get different answers depending on what budget constraint I use. It seems like the book and the slides have conflicting information.
Lindsay Appell
(1 + r)c1 + (1 + pi)c2 = (1 + r)m1 + m2 is the budget constraint that was used in past quarters, so that’s probably why it’s still on the answers. However, this would still be the correct form to use if m1 and m2 were given to you on the test in nominal terms (meaning that they’re not adjusted for inflation). My understanding though is that they’re now focusing on real terms instead of nominal terms. So, most likely on the test you’ll be given m1 and m2 in real terms (meaning that they are adjusted for inflation) and you would use the budget constraint (1 + rho)c1 + c2 = (1 + rho)m1 + m2.
A quick way to remember it is that if your prompt gives you m1 and m2 in nominal terms, you use the nominal BC (the old one). If your prompt gives you m1 and m2 in real terms, you use the real BC (the new one).
You may want to double check all this with the professor though just to make sure!
-Lindsay