Suppose Tilia Thyme can choose between expenditures today and expenditures tomorrow. She has $25,000 in assets and an income today of $45,000.  Given the state of the economy, she expects no raise next year.  Current interest rates are 5%.  The price of consumption is $1000.  

a. Write the equations representing Tillia Thyme’s resources in year 1 and year 2. Calculate total resources available in year 1 and year 2.

b. Graph Tillia’s budget line on the graph below. Label all axes and show numbers for the intercepts. What is the slope?

c.

c. Identify clearly on your graph how much Tillia could consume if she spent:

  i. only her current income;

ii. her current income and assets;

iii. the range of consumption available if she borrows.  

What is the maximum size of a loan she can obtain?  

d. Redraw the budget line on another graph. Draw in an indifference curve representing the fact that Tillia is future oriented (a saver), ceteris paribus.  Clearly identify what the optimal quantities of consumption are in year 1 and year 2, based on where you drew her indifference curve.

e. Now graph the comparative statics of an interest rate increase.

f. Does the new rate of interest help savers like Tillia?  Why or why not?  Who is the policy going to help or hurt and why?