Question 1 (25 marks)

Koi is currently earning $20,000 and expected a higher income of $31,500 at next year. The interest rate in the perfect capital market is now 5%.

(a)Calculate the maximum possible consumption available to Koi in the current year and next year with the mentioned interest rate. (6 marks)

(b)If his utility function from the current consumption (c1) and future consumption (c2) is U(c1, c2) = c1c2^0.6, calculate his optimum level of current consumption, future consumption based on the budget constraint from part (a).(10 marks)

(c)Analyse if Koi is a lender or borrower based on your answer of part (b).(4 marks)

(d)Analyse how imperfect capital market affects Koi's welfare compares to part (c) with the aid of an appropriate diagram.(5 marks)