Aji and Mustapha both obey the two-period model of consumption. Aji earns $100 in the first...

Aji and Mustapha both obey the two-period model of consumption. Aji earns $100 in the first period and $100 in the second period. Mustapha earns nothing in the first period and $210 in the second period. Both of them can borrow or lend at the interest rate r.

You observe both Aji & Mustapha consuming $100 in the first period and $100 in the second period. What is the interest rate r?
Suppose the interest rate increases. In a clearly labeled diagram, what will happen to Aji’s consumption in the first period? Is Aji better off or worse off than before the interest rate? (Hint: what is the substitution effect?)
In a clearly labeled diagram, what will happen to Mustapha’s consumption in the first period when the interest rate increase? Is Mustapha better off or worse off than before the interest rate?

Expert Solution

Rahul Sunny answered 1 year ago

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