What is the maximum size of a loan this consumer can take

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Reference no: EM13148270

Imagine a consumer lives for two periods. In the first period she receives M1 and in the second time period she receives M2. Any income that is not consumed in the first period can be saved in a bank account, which pays interest r on each dollar and can be used for consumption in the next period, i.e. you put $1 in the bank you get $1(1 + r) back tomorrow. Also assume, that an individual can borrow money at rate r against future income, i.e. if you want $1 today you have to pay back $1(1 + r) in period 2. The consumer decides how much of her income to consume in each period. Call consumption in period 1, C1 and consumption in period 2, C2. In your rough notes place C1 on the x-axis of your diagram and C2 on the vertical. Imagine the consumer does not consume anything in period 2 and consumes everything in period 1 (including any loan amount). What is the maximum size of a loan this consumer can take out? Denote the size of the loan in period 1 dollars as x a) x = M2/(1+r) b) x = M2 c) x = M2(1 + r) d) x = M1

Reference no: EM13148270

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