Question

Suppose income is 1000 bundles in periods 1 and 2. Suppose if you borrow, you must pay the interest rate 8%, but if you lend, you only receive the interest rate 5%. Draw the household’s intertemporal budget constraint.

Answer 1

Ans ) If the consumer is borrower then he have to give interest on his borrowings :

1000+ 1000*8/100( this is percentage of 1000 which he have to return in next period as a result the consumer budget will reduce by the same amount because of interest rate he have to pay)

= 1000+80

= 1080 (this period amount is greater then his income)

While when a consumer is lender then he will enjoy grater amount of his income because of interest rate he has earned:

1000-1000*5/100

= 1000-50

= 950 (this period income is less then his income)

Budget constraints for both is given below:

When a consumer is borrower:

M1= income in period 1

M2= income in period 2

C1= consumption in period 1

C2= consumption in period 2

As from figure it can be seen that when a consumer is borrower then his income is less then his consumption. But in future his income will be less because he have to pay the interest rate.

When a consumer is lender then :

Then his income is greater then consumption he will save the amount left and lend the saved amount as a result he will enjoy greater consumption in next period. But his consumption is less in this period.

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