Consider a consumer that lives only for two periods. He works in period 1 (and gets income Y1) and moves upthe corporate ladder in period 2 (and gets income Y1 < Y2).This consumer has the usual preferences over time: u(C1) + Bu(C2)1. Assume this consumer cannot borrow. What is the consumption in period 1 and period 2?Display graphically. Show the corresponding utility curve.2. Assume that now the consumer is allowed to save or borrow. Write down the new budget constraint.What is the consumption in period 1 and period 2? Display graphically. Could the consumer be worseoff? Could the consumer be better off? Draw budget constraints such that for one of them consumerprefers to borrow and for the other - prefers to save.3. Assume once again that a consumer cannot borrow, but can borrow and immediately sell someMacGuffins, and in the next period, the consumer must buy back the MacGuffins to return to thelender. Assume that MacGuffin trades at Pı >0 in the first period and is expected to trade at P2in the second period. Write down the new budget constraint. Would a consumer borrow a MacGuffin?What is the condition on the P2? Is P2 a fair price of a MacGuffin? Could the consumer be better offwith a MacGuffin?

Answered: Consider a consumer that lives only for…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Consider a consumer that lives only for two periods. He works in period 1 (and gets income Y1) and moves up
the corporate ladder in period 2 (and gets income Y1 < Y2).
This consumer has the usual preferences over time: u(C1) + Bu(C2)
1. Assume this consumer cannot borrow. What is the consumption in period 1 and period 2?
Display graphically. Show the corresponding utility curve.
2. Assume that now the consumer is allowed to save or borrow. Write down the new budget constraint.
What is the consumption in period 1 and period 2? Display graphically. Could the consumer be worse
off? Could the consumer be better off? Draw budget constraints such that for one of them consumer
prefers to borrow and for the other - prefers to save.
3. Assume once again that a consumer cannot borrow, but can borrow and immediately sell some
MacGuffins, and in the next period, the consumer must buy back the MacGuffins to return to the
lender. Assume that MacGuffin trades at Pı >0 in the first period and is expected to trade at P2
in the second period. Write down the new budget constraint. Would a consumer borrow a MacGuffin?
What is the condition on the P2? Is P2 a fair price of a MacGuffin? Could the consumer be better off
with a MacGuffin?

Expert Solution

Step 1

Concerning two commodities, an indifference curve is a graph that shows which combinations of the two commodities leave the consumer equally well off or equally satisfied—hence indifferent—in owning any combination on the curve.

Indifference curves are heuristic devices used in modern microeconomics to show consumer preferences and budget constraints. In the study of welfare economics, economists have accepted the ideas of indifference curves.

A simple two-dimensional graph is used in standard indifference curve analysis. Each axis corresponds to a different form of economic good. The consumer is unconcerned about any of the combinations of commodities indicated by points on the indifference curve because each combination of products on the curve provides the same level of utility to the consumer.

For example, a young child might not care if he has two comic books and one toy truck or four toy trucks and one comic book. Hence both of these combinations would be points on the young boy's indifference curve.

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