DIAMOND-DYBVIG BANKING MODEL:

Expected utility = tU(c1) + (1 t)U(c2)

MRSc1,c2= tMUc1/(1-t)MUc2.

1. Describe how the slope of the indifference curve on the 45 degree line (where c1 = c2) depend on t.
2. Depict the possible consumption bundle without the bank (cA_1 , cA_2 ) on a diagram, and explain how the location of this point depends on r.
3. Draw the indifference curve for the consumer going through the point (cA1 , cA2 ).
4. Using the above argument ( in a separate diagram), explain how the Diamond-Dybvig deposit contract (cB1 , cB2 ) can be constructed to offer potentially a higher expected utility for the consumers. When is it not possible to offer such a contract? Explain as clearly and as detailed as you can how this construction depends on t and r.