Exercise 2

Exercise 2. (15 points) Nick has an income of $2,000 this year and he expects an income of $1,000 next year. Suppose that his utility function is u(cl, (:2) = 01/30:\". He can borrow and lend money at an interest rate of 10%. Consumption goods cost $1 per unit this year and there is no ination. What is Nick's consumption this year and the next? Will he borrow or save in the rst period? How much? Assume that the interest rate rises to 20% and draw Nick's new intertemporal budget line. Knowing what Nick chose at a 10% interest rate, even without knowing his utility function, you can determine that his new choice cannot be on certain parts of his new budget line. Scribble over the part of his new budget line where that choice cannot be