Suppose that a person can borrow and lend at an interest rate of 10%.But there is a 5% rate of inflation and the person has to pay an income tax of 30% on all interest income.If the person borrows money, he can deduct interest as an expense.Where current consumption is on the horizontal axis and future consumption is on the vertical axis, the budget line will
A)have a kink at the point of no saving or lending.
B)be a straight line with a slope of about -1.02.
C)be a straight line with a slope of about -1.05.
D)be a straight line with a slope of about -1.35.
E)None of the above.

Question

Quizplus · Accepted Answer

The after-tax real interest rate is 10% - 5% * (1 - 30%) = 7%. The slope of the budget line is -7% / (1 + 5%) = -1.02.

Suppose That a Person Can Borrow and Lend at an Interest