ECON 359 - Winter 2026
TUTORIAL 7
Tutorial Activity #20
Consider the two period model of consumption and saving. The consumer
chooses consumption, c and c0 , in the two periods by taking her income, y
and y 0 , and the interest rate as given. Suppose, unlike the model that we
discussed in the class, the borrowing and lending interest rates are different.
Specifically, the borrowing rate, rB , is higher than the lending rate, rL . Use
this assumption, rB > rL , to answer the following questions.
(a) Draw the consumer’s life-time budget constraint on a diagram with c
on x-axis and c0 on y-axis.
(b) What happens to the life-time budget constraint if the consumer’s current income increases but her future income stays the same? Show changes
in the budget constaint in a new diagram.
(c) What happens to the life-time budget constraint if the consumer’s
current income remains the same but her future income increases? Show the
changes in the budget constaint in a new diagram.
(d) Now assume that both current income and future income increase.
Draw the equilibrium of a borrower before and after the change. Clearly
mark the income and substitution effects. Briefly explain your results.
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Tutorial Activity #21
The problem of a representative consumer is to maximize utility
U = c0.4 (c0 )0.6
subject to
c + 0.8c0 = 10,
where c is her current period consumption and c0 is her future period
consumption. Use the Lagrange multiplier method to solve this problem.
Tutorial Activity #22
An employer offers an employee the option of shifting x units of income from
next year to this year. That is, the option is to reduce income next year by
x units and increase income this year by x units.
(a). Would the employee take this option?
(b). Determine, using a diagram, how this shift in income will affect consumption this year and next year and saving this year. For simplicity assume
the consumer is saver before and after the change.
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