Please answer me in 40 minutes Question 1

Suppose a consumer who receives 0 income in the current period, and income y' in the future period. There are no taxes. The consumer can borrow in the current period at the real interest rate r. In the future period, the consumer could decide to default on the debt acquired in the current period. If the consumer chooses to default, he or she consumes his or her income y minus a default cost v. Here, v represents legal penalties.

(a) Under what conditions will the consumer choose to default, and under what conditions

will he or she not default? (b) Assume that lenders understand the consumer's behaviour and will not lend so much to the consumer that he or she will choose to default on his or her debt. Determine the effects of an increase in the real interest rate on the consumer's current and future consumption, and on borrowing. Show this in a diagram.