Question

Following the Fisher’s intertemporal decision framework discussed in class, show in a diagram how the optimal consumption in the current and future period for an individual who is a net lender. Make sure you clearly label all the axes and curves and critical points on them.

Answer 1

Fisher's model of intertemporal consumption based on three assumptions:

1. Budget constrants faced by consumers,

2. Their preferences between current and future consumption,

3. How to determine household's decision regarding optimal consumption and saving over an extended period of time.

If the person is net lender,then :

S = Y1 - C1.

C2 = (1+r)S + Y2.

We get the optimal consumption in the current and future period, where the indifference curve tangent to the budget constraint.