Reference no: EM133078682

Consider Sally and Bob. They both live for two periods and have the same stream of income, Y1 in the first period and Y2 in the second period. However, given their different preferences for current and future consumption, at the market interest rate r, Sally saves part of her first period income for consumption in the second period and Bob borrows during the first period. If the interest rate were higher, how would Sally and Bob each adjust their current consumption, future consumption, and amount of saving or borrowing in the first period? You may assume that consumption in each period is a normal good for both consumers. Does the higher interest rate make them better off or worse off?