Question

Question 4. Laura is deciding how much to consume in periods o, 1 and 2. Suppose Laura income in period o is o, her income in period is y, and her income in period alsay. The price of consumption in period / is p. Assuming the interest rate is T, and consumption in period is denoted. In the utility maximization problem what variables are endogenous and which are exogenous ? Figure 1. Consider the following diagram of an indifference curve over consumption today (0) and tomorrow (es), and the intertemporal budget constraint. 1 Question 5. Referring to figure 1, at the optimum, is this person borrowing or saving? Question 6. Referring to figure 4, illustrate how an increase in the interest rate would affect the intertemporal budget constraint and the optimum consumption decision. Would this person increase their savings or borrowing if interest rates increased?

Answer 1

Question 4 :

Endogenous Variables- The variables whose solution we are finding. In the utility maximization problem the endogenous variables are consumption in different time periods- 0,1 and 2.

Exogenous Variables- The variables that are provided to us. In the utility maximization problem the exogenous variables are income in period 0, 1 and 2; interest rate (r) and price of the consumption.

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Question 5:

Referring to figure 1, the person is neither the borrower nor the lender at the optimum. if the consumption is below the optimum, the person is the lender and if its above, the person is borrower. At optimum, where Indifference curve is tangent to the budget constraint, the person is consuming whatever he has in the current period.

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