Graphically demonstrate the FST for the case where an individual ends up borrowing in the financial markets. Label the following points on the graph: initial wealth, W0; optimal production/investment (P0*,P1*); optimal consumption (C0*,C1*); present value of final wealth, W0*. Comment how you get to the optimal decisions.

b) Describe and graphically analyze the effect of an exogenous increase in the interest rate on:

i- The present wealth of borrowers and lenders

ii- The utility of lenders and borrowers

c) Suppose that capital markets involve higher borrowing rate than the lending rate, does FST still hold? Explain? Illustrate graphically the optimal production decisions for a borrowers and a lenders.