Suppose that you have $100 today and expect to receive $100 one year from today. Your money market account pays an annual interest rate of 25%, and you may borrow money at that interest rate. Consider the budget constraint between "spending today" on the horizontal axis and "spending a year from today" on the vertical axis. What is the slope of this budget constraint?
A)−0.75
B)−1.00
C)−1.25
D)−2.25

Question

Quizplus · Accepted Answer

The slope of the budget constraint is determined by the interest rate for borrowing or saving. With a 25% interest rate, $1 saved today becomes $1.25 a year from today, and $1 borrowed today needs $1.25 to repay in a year. Thus, the slope, which represents the trade-off between spending today and a year from today, is -1.25.

Suppose That You Have $100 Today and Expect to Receive