2. Consider an individual who lives only two periods. Let c> 0 be consumption in period 1 and > 0 be consumption in period 2. Therefore, (1, 2) is the intertemporal) consumption bundle. Let p be the price of the good in period 1. In period 2, the price is higher due to inflation. Let (0,1) be the rate of inflation. For t = 1,2, her (per-period) income is 11 > 0. In addition to receiving income, she may save or borrow in period 1. Let S (-1/(1+i), 11) be the amount that is saved or borrowed in period 1. If she saves (i.e., s > 0), then she receives back her savings plus interests at the beginning of period 2. If she borrows (i.e., s 19/p2 in period 2. What is p2 in this problem? (b) The individual decides to borrow when she wishes to consume 4 > 1/P1 in period 1. Note that the individual is not allowed to borrow more than 12/(1+i). In other words, there is no default in this 1 (a) For s (-1./(1+1), 11), write down an equation for the intertemporal budget line (i.e., an equation in terms of c and ca). (2 points) (b) Sketch the intertemporal budget line and indicate the segment corresponding to s (-12/(1+i), 0], the segment corresponding to s = 0, and the segment corresponding to s (0,11]. What do each of these cases represent? Clearly label your graph. (2 points) (c) Show graphically the effect of an increase in inflation on the budget set. (1 point) 2. Consider an individual who lives only two periods. Let c> 0 be consumption in period 1 and > 0 be consumption in period 2. Therefore, (1, 2) is the intertemporal) consumption bundle. Let p be the price of the good in period 1. In period 2, the price is higher due to inflation. Let (0,1) be the rate of inflation. For t = 1,2, her (per-period) income is 11 > 0. In addition to receiving income, she may save or borrow in period 1. Let S (-1/(1+i), 11) be the amount that is saved or borrowed in period 1. If she saves (i.e., s > 0), then she receives back her savings plus interests at the beginning of period 2. If she borrows (i.e., s 19/p2 in period 2. What is p2 in this problem? (b) The individual decides to borrow when she wishes to consume 4 > 1/P1 in period 1. Note that the individual is not allowed to borrow more than 12/(1+i). In other words, there is no default in this 1 (a) For s (-1./(1+1), 11), write down an equation for the intertemporal budget line (i.e., an equation in terms of c and ca). (2 points) (b) Sketch the intertemporal budget line and indicate the segment corresponding to s (-12/(1+i), 0], the segment corresponding to s = 0, and the segment corresponding to s (0,11]. What do each of these cases represent? Clearly label your graph. (2 points) (c) Show graphically the effect of an increase in inflation on the budget set. (1 point)