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

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) $1000 / 1.1 + 1200 / 1.1 + 1$.

Quizplus · Accepted Answer

The point of maximum future consumption occurs where the budget constraint is tangent to the highest indifference curve. This point can be found by taking the present income (1000) and adding the present value of the future income (1200/1.1 = 1091). This gives us 1000(1.1) + 1091 = 2191, which represents the maximum amount that can be spent in both time periods while still being able to repay the loan with interest. This corresponds to point B on the graph where the budget constraint is tangent to the highest indifference curve. To find the point of maximum future consumption, we need to find the budget constraint for the consumer. The equation for the budget constraint is given by:
C1 + C2/(1+r) = Y1 + Y2/(1+r)
where C1 and C2 are current and future consumption respectively, Y1 and Y2 are current and future income respectively, and r is the interest rate. Substituting the given values, we get:
C1 + C2/1.1 = 1000 + 1200/1.1
Solving for C2, we get:
C2 = (1.1*C1 + 1200) - 1100
To maximize future consumption, we need to set C2 as high as possible, given the budget constraint. This occurs when all the income in period 1 is saved and invested at the interest rate of 10%. Therefore, the maximum future consumption can be expressed as:
C2 = 1.1*C1 + Y2
Substituting the given values, we get:
C2 = 1.1*1000 + 1200
C2 = 2200/1.1
C2 = 2000
Therefore, the point of maximum future consumption is (1000, 2000) which corresponds to option B.

When Analyzing How Borrowing and Lending Affect the Consumer's Budget 1000+1200/1.11000 + 1200 / 1.11000+1200/1.1

When Analyzing How Borrowing and Lending Affect the Consumer's Budget $1000 + 1200 / 1.1$