Marsha Mellow doesn’t care whether she consumes in period 1 or in period 2. Her utility function is simply U(c1, c2) = c1 + c2. Her initial endowment is $20 in period 1 and $40 in period 2. In an antique shop, she discovers a cookie jar that is for sale for $12 in period 1 and that she is certain she can sell for $20 in period 2. She derives no consumption benefits from the cookie jar, and it costs her nothing to store it for one period.
(a) On the graph below, label her initial endowment, E, and use blue ink to draw the budget line showing combinations of period-1 and period-2 consumption that she can afford if she doesn’t buy the cookie jar. On the same graph, label the consumption bundle, A, that she would have if she did not borrow or lend any money but bought the cookie jar in period 1, sold it in period 2, and used the proceeds to buy period-2 consumption. If she cannot borrow or lend, should Marsha invest in the cookie jar?
(b) Suppose that Marsha can borrow and lend at an interest rate of 50%. On the graph where you labeled her initial endowment, draw the budget line showing all of the bundles she can afford if she invests in the cookie jar and borrows or lends at the interest rate of 50%. On the same graph use red ink to draw one or two of Marsha’s indifference curves.
(c) Suppose that instead of consumption in the two periods being perfect substitutes, they are perfect complements, so that Marsha’s utility function is min{c1, c2}. If she cannot borrow or lend, should she buy the cookie jar?_______. If she can borrow and lend at an interest rate of 50%, should she invest in the cookie jar? _______. If she can borrow or lend as much at an interest rate of 100%, should she invest in the cookie jar?_____.