Question 4 (8 marks)
a) (2) Frida gets an income of $1000 today and $1000 next year. Assume she uses her
income to either consume (or save/borrow today) and consume tomorrow. Her
endowment point is where she would neither borrow nor save today. In a diagram plot
consumption today on the horizontal axis and consumption next year on the vertical axis
and clearly identify her endowment point.
b) (2) In the same diagram as a), if the interest rate is 10%(r=0.1) show the maximum
consumption (in $ ) that she could have if she saved all her income today and consumed
all her income next year. Similarly, show the maximum consumption (in $ ) that she could
have if she borrowed from her future income to have more consumption today than her
income today would let her.
c) (2) Draw a new diagram that has all of the details from your diagram in a). You must
draw a new diagram. Assume that Frida is very patient and is willing to save today in
order to have more consumption next year. Where would her indifference curve be to
show her optimal choice of consumption today versus consumption tomorrow.
d) (2) Suppose the interest rate rises to 20% ( r=0.2 ). You do not need to draw a diagram but
explain whether you think Frida will save more or less of today's consumption than she
did when the interest rate was 10%(r=0.1). Explain your answer.
e) Bonus Question (2): draw a completely labelled diagram to illustrate your answer to
d).
Question 4(8 marks)
a) 2Frida gets an income of $1000 today and $1000 next year.Assume she uses her income to either consume (or save/borrow today) and consume tomorrow. Her endowment point is where she would neither borrow nor save today.In a diagram plot
consumption today on the horizontal axis and consumption next year on the vertical axis and clearly identify her endowment point.
b) 2In the same diagram as a),if the interest rate is 10%(r=0.1 show the maximum consumption (in $) that she could have if she saved all her income today and consumed all her income next year.Similarly, show the maximum consumption (in S that she could have if she borrowed from her future income to have more consumption today than her income today would let her. C) (2 Draw a new diagram that has all of the details from your diagram in a).You must draw a new diagram. Assume that Frida is very patient and is willing to save today in order to have more consumption next year.Where would her indifference curve be to show her optimal choice of consumption today versus consumption tomorrow d)(2) Suppose the interest rate rises to 20%(r=0.2).You do not need to draw a diagram but explain whether you think Frida will save more or less of today's consumption than she did when the interest rate was 10% (r=0.1). Explain your answer. e) Bonus Question (2):draw a completely labelled diagram to illustrate your answer to d).