Making financial decisions has never been one of Alice's strengths, so she decides to hire a financial consultant, the only one available is You. We know Alice only cares about consumption today and tomorrow, and that she will obtain income m1 in period 1 and m2 in period 2.
Answer the following questions (again, show all your work, it can make a difference):
a) Assume she cannot borrow or lend in any way, and U(c1,c2) = c1*c2; what would be your advice regarding her consumption decisions for the two periods of analysis?
b) Can you draw, label the axis, and label the intercepts of the budget line if she can borrow or lend at an interest rate of r?
c) What is the slope of the budget constraint if the interest rate r is 10%? First assume inflation is negligible, and then assume inflation is 5%.
d) Remembering her utility function from a), and assuming p1=p2=1, interest rate is 10%, and that m1= 100 and m2=115; how much would she consume in period 1, and how much in period 2? (Notice that now the no borrowing, no lending restriction has been lifted).