ENGR.ECONOMIC ANALYSIS
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ISBN: 9780190931919
Author: NEWNAN
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Problem 4 - Costless Magical MacGuffin
Consider a consumer that lives only for two periods. He works in period 1 (and gets income Y1) and moves up the
corporate ladder in period 2 (and gets income Y1 < Y2). This consumer has the usual preferences over time: u(C1) +βu(C2)
Assume this consumer cannot borrow.
1. What is the consumption in period 1 and period 2? Display graphically. Show the corresponding utility
curve.
Assume that now the consumer is allowed to save or borrow.
2. Write down the new budget constraint. What is the consumption in period 1 and period 2? Display
graphically. Could the consumer be worse off? Could the consumer be better off? Draw budget constraints
such that for one of them consumer prefers to borrow and for the other - prefers to save.
Assume once again that a consumer cannot borrow, but can borrow and immediately sell some ‘MacGuffins’, and in the next period, the consumer must buy back the MacGuffins to return to the lender. Assume that MacGuffins trade at P1 > 0 in the first period, and is expected to trade at P2$ in the second period.
3. Write down the new budget constraint.
4. Under what conditions would a consumer borrow and then sell a MacGuffin? Would they be better
off with this option?
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