3.4 The following figure depicts the financial situation of Ms. J. Fawn. In period 0 her labor income and current consumption is $40; later, in period 1, her labor income and consumption will be $22. She has an opportunity to make the investment represented by point D. By borrowing and lending, she will be able to reach any point along the line FDE.

a. What is the market rate of interest? (Hint: The new market interest rate line EF is parallel to AH.)

b. What is the NPV of point D?

c. If Ms. Fawn wishes to consume the same quantity in each period, how much should she consume in period 0?

Transcribed Image Text:

Period 1 ($) F -(1+r) H 22 22 D C B A E Period 0 ($) 40 60 75