Question

ny people have difficulty borrowing as much money as they want, even if they are confident that their incomes in the future will be high enough to easily pay back the borrowed funds. For example, many students in medical school will earn high incomes after they graduate and become physicians. if the could, they would probably borrow now in order to live more comfortably while in medical school and pay the loans back out of their higher future income. Unfortunately banks are reluctant to make loans to people who currently have low incomes, even if there is a good chance their incomes will be higher in the future. If people could always borrow as much as they want to, would you expect consumption to become more or less sensitive to current income? Please explain.

Answer 1

When, consumption of today is in the tune of future income and consumption of today is financed by the borrowed funds, then consumption of today, will be less sensitive to the current income. It will happen, because consumption of today, will be financed by the borrowings. So, consumption will be less dependent upon the current income.

Though, banks will be reluctant to issue the borrowings, because future comes with uncertainties and banks increase the discount rate to the future promised income and accordingly, issue loans.