An individual has $100,000 in income today, but no income in the future, and we are considering the tradeoff between consumption now and consumption in the future. Assume that consumption now and the future can be considered normal goods. Let savings be defined as any income not consumed today.

a. Draw the budget constraints with a rate of return on savings (interest rate) of 10% and 20%.

b. Suppose that indifference curves are perfect complements (L-shapedwith the kink occurring whenever consumption today is equal to consumption in the future.) Can you tell whether the household will save more or less as a result of the rate increase? How?

c. You are asked to advise Congress on a policy of subsidizing savings in order to increase the amount people save. Specifically, Congress proposes 5% in interest payments in addition to the regular market rate. Evaluate the following statement. Assuming consumption is a normal good, small substitution effects make it likely that savings will actually decline as a result of this policy, but large substitution effects make it likely that savings will increase.

d. True/False and why: If you only care about whether future consumption increases with this policy, then all you need to know is that consumption is a normal good.