M&B3 3rd Edition by Dean Croushore

Exercise 16

Draw a fi gure showing a household's budget constraint in a two-period model if the household's income is $10,000 in period 1 and $12,000 in period 2, and the interest rate is 20 percent. Assume that the price of the good is $1 in both periods. Show three points on the budget constraint: the point with no borrowing or saving, the point with all consumption in period 2, and the point with all consumption in period 1. Show what happens to the budget constraint if the interest rate rises to 40 percent. Show the same three points as before.