) Consider an economy where individuals live for 2 periods and have prefer- ences represented by
ln(c) + ß ln(c')
where c and c' represent consumption in the first and second period, respectively. Income is denoted y in the first period and y' in the second. The real interest rate is denoted r.
(a) Whatistheequilibriumrateofinterestonthecreditmarket?Explainhowyou derived it.
(b) In a recession the rate of growth of income decreases, that is y'/y decreases. What does this model predict about the behavior of the interest rate in a re- cession? Why?