3. (**) a. Suppose Y1 = 100,Y2 = 200, r = 0.1. Suppose a borrowing constraint ex

Question

3. (**) a. Suppose Y1 = 100,Y2 = 200, r = 0.1. Suppose a borrowing constraint exists such that the consumer cannot borrow in period 1. Assume that in the absence of the constraint, the consumer would be a borrower in period 1. Under the borrowing constraint how much will the consumer consume in period 1 and period 2? (Give numerical answers) [1 point] (*") b. In question 3a above, suppose that in absence of the borrowing constraint, the consumer would be a saver in the first period. If a borrowing constraint is imposed, will the consumer's optimum consumption be affected in any way? Answer Yes or No. [1 point]

Explanation / Answer

a) In the absence of Borrowing constraint, the consumer would borrow in Period 1. Hence, his utility is maximised at some level of Period 1 consumption which is greater than the Period 1 Income of 100. Thus, in the presence of Borrowing constraint, the consumer would consume all the available amount of Income in the first period.

Thus, Period 1 consumption is 100 and Period 2 consumption is 200.

b) No.

If the consumer is a saver in Period 1, then the borrowing constraint in period 1 is NON-BINDING for him. Hence, there would be no change in the optimal consumption in Period 1.

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