Harvey Habit’s utility function is U (c1, c2) = min {c1, c2}, where c1 is his consumption of bread in period 1 and c2 is his consumption of bread in period 2. The price of bread is $1 per loaf in period 1. The interest rate is 21%. Harvey earns $2,000 in period 1 and he will earn $1,100 in period 2.
(a) Write Harvey’s budget constraint in terms of future value, assuming no inflation.
(b) How much bread does Harvey consume in the first period and how much money does he save? (The answer is not necessarily an integer.)
(c) Suppose that Harvey’s money income in both periods is the same as before, the interest rate is still 21%, but there is a 10% inflation rate. Then in period 2, a loaf of bread will cost _________. Write down Harvey’s budget equation for period-1 and period-2 bread, given this new information. __________.