please answer (iv)(v) 2 Different Rates for Borrowing and LendingIn Class we considered the case in which the consumer can borrow and lend freely and the interest rate r. We alsoconsidered the case in which the individual can save at rate r but cannot borrow at all.Consider now the intermediate case in which the interest rate charged by the bank for borrowing is larger than theinterest rate paid by the bank to the consumer for the money they deposit in the bank. In other words, the consumer canSAVE at the rate rs (s for saving) and can BORROW at rate rp (b for borrowing) with rp > rs. The individual receives y1and y2 in periods 1 and 2 respectively.(i) Graph the budget constraint for the individual.(ii) Add to your graph the consumer's indifference curves. Show graphically three possible outcomes: one in whichthe consumer saves, one in which he borrows, and one in which he neither borrows nor saves.• (iii) Consider the case in which he SAVES. How does consumption in period 1 change when the interest rate rbincreases a little bit? How does consumption in period 1 change when the interest rate rs increases a little bit?• (iv) Consider now the case in which he BORROWS. How does consumption in period 1 change when the interestrate rp increases a little bit? How does consumption in period 1 change when the interest rate rs increases a littlebit?• (v) Finally, consider the case in which he does NOT BORROW OR SAVE. How does consumption in period 1change when the interest rate rp increases a little bit? How does consumption in period 1 change when the interestrate rs increases a little bit?

A Budget Constraint is defined as the all the combinations of goods and services a consumer can afford with his given level of income. Every point on the budget constraint indicates the combination of goods the consumer can buy before he exhausts his entire income. Given, Interest rate r The interest rate charged by the bank for borrowing is larger than the interest rate paid by the bank The consumers save at rate rs and borrow at rate rb where rb>rs The consumer receives y1 and y2 in periods 1 and 2 respectively When the consumer is a borrower, his consumption in period 1 will decrease if the rate of interest on borrowing increases. There will be a fall in the borrowing. If rate of interest on savings increases, the consumption will increase since there will be a larger supply of savings. If the consumer decides to neither borrow, nor save, the increase in rate on interest on both borrowings and savings will not affect the consumer and his consumption decision. Any change in the rate on interest will not affect the consumer in any way and his consumption will remain the same.

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In Class we considered the case in which the consumer can borrow and lend freely and the interest rate r. We also considered the case in which the individual can save at rate r but cannot borrow at all. Consider now the intermediate case in which the interest rate charged by the bank for borrowing is larger than the interest rate paid by the bank to the consumer for the money they deposit in the bank. In other words, the consumer can SAVE at the rate rs (s for saving) and can BORROW at rate ro (b for borrowing) with rb > rs. The individual receives y1 and y2 in periods 1 and 2 respectively.

In Class we considered the case in which the consumer can borrow and lend freely and the interest rate r. We also considered the case in which the individual can save at rate r but cannot borrow at all. Consider now the intermediate case in which the interest rate charged by the bank for borrowing is larger than the interest rate paid by the bank to the consumer for the money they deposit in the bank. In other words, the consumer can SAVE at the rate rs (s for saving) and can BORROW at rate ro (b for borrowing) with rb > rs. The individual receives y1 and y2 in periods 1 and 2 respectively.

Principles of Economics 2e

2nd Edition

ISBN:9781947172364

Author:Steven A. Greenlaw; David Shapiro

Publisher:Steven A. Greenlaw; David Shapiro

Chapter17: Financial Markets

Section: Chapter Questions

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Question

please answer (iv)(v)

2 Different Rates for Borrowing and Lending
In Class we considered the case in which the consumer can borrow and lend freely and the interest rate r. We also
considered the case in which the individual can save at rate r but cannot borrow at all.
Consider now the intermediate case in which the interest rate charged by the bank for borrowing is larger than the
interest rate paid by the bank to the consumer for the money they deposit in the bank. In other words, the consumer can
SAVE at the rate rs (s for saving) and can BORROW at rate rp (b for borrowing) with rp > rs. The individual receives y1
and y2 in periods 1 and 2 respectively.
(i) Graph the budget constraint for the individual.
(ii) Add to your graph the consumer's indifference curves. Show graphically three possible outcomes: one in which
the consumer saves, one in which he borrows, and one in which he neither borrows nor saves.
• (iii) Consider the case in which he SAVES. How does consumption in period 1 change when the interest rate rb
increases a little bit? How does consumption in period 1 change when the interest rate rs increases a little bit?
• (iv) Consider now the case in which he BORROWS. How does consumption in period 1 change when the interest
rate rp increases a little bit? How does consumption in period 1 change when the interest rate rs increases a little
bit?
• (v) Finally, consider the case in which he does NOT BORROW OR SAVE. How does consumption in period 1
change when the interest rate rp increases a little bit? How does consumption in period 1 change when the interest
rate rs increases a little bit?

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