Addendum to Ch 3and4 Econ 281 Fall2010_Borrowing and Lending

# Addendum to Ch 3and4 Econ 281 Fall2010_Borrowing and...

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Example:  Borrowing and Lending Two composite goods: C 1   is what the consumer consumes of the first  period composite good (spending this year) C 2   is what the consumer consumes of the  second period composite good (spending next  year) C 1 , spending this year (\$) C 2 , spending next year (\$)
C 1 , spending this year (\$) C 2 , spending next year (\$) I 1 I 2 I 1 +I 2 /(1+r) I 2 + I 1 (1+r) A I 1   is the consumer income for the first period I 2   is the consumer income for the second period r  is the Bank interest rate for borrowing and  lending Slope of budget line is -(1+r)

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C 1 , spending this year (\$) C 2 , spending next year (\$) I 1 I 2 C 1B C 2B I 1 +I 2 /(1+r) I 2 + I 1 (1+r) B A C 1B  –I 1  = How much the  consumer borrows from  the bank today  (C 1B  –I 1 ) (1+r) = How  much the consumer  has  to give back to the bank  tomorrow
C 1 , spending this year (\$) C 2 , spending next year (\$) I 1 I 2 C 1B C 2B I 1 +I 2 /(1+r) I 2 + I 1 (1+r) B A Tangency condition: MRS =(1+r) IC 1 IC 2 This consumer anticipates consumption

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