The chapter analyzes Fisher’s model for the case in which the consumer can save or borrow at an interest rate of r and for the case in which the consumer can save at this rate but cannot borrow at all. Consider now the intermediate case in which the consumer can save at rate r s and borrow at rate rb, where rs < rb.
a. What is the consumer’s budget constraint in the case in which he consumes less than his income in period one?
b. What is the consumer’s budget constraint in the case in which he consumes more than his income in period one?
c. Graph the two budget constraints and shade the area that represents the combination of first-period and second-period consumption the consumer can choose.
d. Now add to your graph the consumer’s indifference curves. Show three possible out-comes: one in which the consumer saves, one in which he borrows, and one in which he neither saves nor borrows.
e. What determines first-period consumption in each of the three cases?