Sara earns $200 in the first period and $100 in the second period. She lives in the

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Question:

Sara earns $200 in the first period and $100 in the second period. She lives in the two- period Fisher model of consumption. Therefore, she can borrow or lend at the interest rate r. Considering the two-period Fishers model,

1. Write down her intertemporal budget constraint.

2. Assume that She is consuming $150 in the first period and $160 in the second period. What is the interest rate?

3. Now assume that r=20%, (and Y1 = $200, Y2 = $100). Draw the intertemporal budget constraint (IBC). Determine the maximum possible C1 and C2. You can also add an indifference curve (IC) that is tangent to the point C1 = $150 and C2 = $160 of this IBC. Call this as Figure 2.

4. What will happen to Saras consumption if the interest rate declines to r=10%. Support your interpretation by updating Figure 2 and call the new figure as Figure 2.1.

5. What will happen to Saras consumption if the interest rate increases to r=30%. Support your interpretation by updating Figure 2 and call the new figure as Figure 2.2.

6. What is a borrowing constraint? Do you think that Sara is facing a borrowing constraint? Why?