Consider a two-period model with Dave's utility given by u(x1; x2) where
x1 represents his consumption during the rst period and x2 is his second period's con-
sumption. Dave is endowed with (x1; x2) which he could consume in each period, but he
could also trade present consumption for future consumption and vice versa. Thus, his
budget constraint is
p1x1 + p2x2 = p1x1 + p2x2
where p1 and p2 are the st and second period prices respectively.
1. Derive the Slutsky equation in this model (Note that now Dave's income depends
on the value of his endowment which, in turn, depends on prices: m = p1x1+p2x2.)
2. Assume that Dave's optimal choice is such that x1 < x1. If p1 goes down, will Dave
be better o or worse o ? What if p2 goes down?
3. What is the rate of return (ROR) on the consumption good?