Question

Q4 ) John earns income of 400 units in the first period and 300 units in the second period.

Further suppose that John can borrow money at an interest rate of 8%.

(a) Draw his budget constraint recalling that c2 = Y1(1 + r) + Y2 − (1 + r)c1.

(b) Draw John’s budget constraint if he only receives income in the first period.

(c) Draw John’s budget constraint if he only receives income in the second period.

(d) Now assume that John can lend to the bank as well as borrow at the same interest rate and redraw the diagrams.

(e) What is John’s budget constraint if he earns 400 units in the first period and 300 units in the second period, he can still borrow money from the bank at an 8% interest rate, but if he wants to lend between the first and second period he must place his money in a term deposit that only pays a 3% interest rate?

Answer 1