When analyzing how borrowing and lending affect the consumer's budget constraint, we measure spending in the current time period on the horizontal axis and spending in the future time period on the vertical axis. Assume that the interest rate at which the consumer can lend and borrow is 10% and income in period 1 is $1000 while income in period 2 is $1200. The point of maximum future consumption can be expressed as
A) 1000 + 1200/1.1.
B) 1000(1.1) + 1200.
C) 1000+1200+.1.
D) 1000/1.1 + 1200/1.1 + 1.

Question

Quizplus · Accepted Answer

The maximum future consumption occurs when the consumer saves all current income and consumes it in the future, including interest. Thus, future consumption is $1000(1.1) + $1200.

When Analyzing How Borrowing and Lending Affect the Consumer's Budget