Luella has to pay an interest rate of 50% to borrow. She only gets an interest rate of 5% if she lends. She is currently endowed with $1000 in period 1 and $1050 in period 2. She considers two alternative investment projects. She can only choose one of them. For project A she would HAVE TO PAY $500 in period 1 and would BE PAID BACK $630 in period 2. For project B; she would BE PAID $500 in period 1 and would HAVE TO PAY BACK $525 in period 2.
a) Diagram her budget set if she chooses project A. Also show her budget if she chooses project B.
b) If she neither borrows nor lends, which project has the higher present value at the interest rate 50%? Which has the higher present value at an interest rate of 5%?
c) Draw indifference curves such that she should choose A.
d) With di erent preferences might she choose B?