Tom has income of $1000 today and $500 tomorrow. Tom can lend and borrow at an interest rate of 10%. There is 5% ináation. His preferences for intertemporal consumption are represented by the following utility function u(c1; c2) = 2c1 + c2.
(a) What is his optimal consumption bundle?
(b) If interest rates increase to 20%, write down his new intertemporal budget constraint and graphically demonstrate the change to his intertemporal budget constraint and label any changes to the intercepts.
(c) How does this change effect his welfare? Explain.