a)      

Consider individuals who smooth their consumption over their lifetime,

meaning their consumption behavior follows the Permanent Income Hypothesis

(hereafter, PIH). Suppose a person is currently 55 years old and expects to

retire at 65. If individuals receive no income after retirement, will this

person reduce their consumption now in anticipation of a future decline in

income? Discuss.

b)     

Suppose there are individuals in the economy who are hand-to-mouth

workers, meaning they consume all of their income in the current period. What

is the marginal propensity to consume (MPC) for these individuals?

c)      

Now, consider aggregate consumption in the economy. If aggregate

consumption is the sum of consumption by both PIH individuals and hand-to-mouth

workers, explain why the slope of the consumption function (i.e., the ratio of

the change in aggregate consumption to the change in aggregate income) is between zero and one. (1 mark)