2 1 11 1 (' ) ' ( )[ (' ) (')]'0 XXX XXXXXX σ???????=ΩΩΩΩΩ?= Solution 6: (a) When we condition on inc puting an expectation, inc es a constant. So E( u |inc ) = E( inc ? e |inc ) = inc ? E( e | inc ) = inc ?0 because E( e |inc ) = E( e ) = 0. (b) Again, when we condition on inc puting a variance, inc es a constant. So Var ( u | inc ) = Var( inc ? e |inc ) = ( inc ) 2Var ( e |inc ) = 2 e σ inc because Var( e |inc ) = 2 e σ. (c) Families with low es do not have much discretion about spending; typically, a low-e family must spend on food, clothing, housing, and other necessities. Higher e people have more discretion, and some might choose more consumption while others more saving. This discretion suggests wider variability in saving among higher e families.
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