borrowers and savers/lenders

Question 1

What is money?

Answer 1

A medium of exchange like bank notes or deposits, accepted for payment because it can be used to purchase goods and services.

Question 2

How does money differ from barter?

Answer 2

Barter is direct exchange (e.g. apples for oranges), while money allows indirect exchange since it’s accepted by everyone.

Question 3

What makes money effective in modern economies?

Answer 3

Trust—people believe others will accept money in exchange for goods and services.

Question 4

How does money facilitate exchange over time?

Answer 4

It allows purchasing power to be stored and transferred, enabling delayed payments.

Question 5

What is wealth?

Answer 5

The maximum you could consume without borrowing, after paying off debts and collecting money owed to you.

Question 6

What is income?

Answer 6

The flow of money received over time from earnings, investments, or government transfers.

Question 7

What type of variable is income?

Answer 7

A flow variable—measured over time.

Question 8

What type of variable is wealth?

Answer 8

A stock variable—measured at a specific point in time.

Question 9

What is net income?

Answer 9

Disposable income minus depreciation.

Question 10

What does borrowing allow us to do in terms of consumption?

Answer 10

It allows us to bring consumption forward in time—consume more now and less later.

Question 11

What is the opportunity cost of consuming more now?

Answer 11

Consuming less later.

Question 12

How do borrowing and lending affect spending over time?

Answer 12

They let us rearrange when we spend our money—shift purchasing power between periods.

Question 13

What is Julia’s repayment formula?

Answer 13

Repayment = Principal × (1 + r)

Question 14

If Julia borrows $91 at 10% interest, how much does she repay?

Answer 14

$100 → 91 × (1 + 0.1)

Question 15

How is the interest rate calculated?

Answer 15

Interest rate = (Repayment / Principal) - 1

Question 16

What happens if the interest rate increases (e.g., to 78%)?

Answer 16

Julia can borrow less now (only $56), and her feasible frontier shifts inward.

Question 17

What is the marginal rate of transformation (MRT) in this context?

Answer 17

MRT = 1 + r → It’s the rate at which future goods must be given up for present goods.

Question 18

What are the two reasons Julia may be impatient?

Answer 18

(1) She prefers to smooth her consumption over time, and (2) she may just be an impatient person.

Question 19

Why is there a conflict of interest between borrowers and lenders?

Answer 19

Borrowers prefer lower interest rates; lenders benefit from higher rates.

Question 20

What is consumption smoothing?

Answer 20

Choosing to spread consumption evenly over time to avoid consuming everything in one period and nothing in another.

Question 21

What is the law of satiation of wants?

Answer 21

The idea that the value of additional consumption decreases as more is consumed—also called diminishing marginal returns to consumption.

Question 22

What is diminishing marginal returns to consumption?

Answer 22

The more you consume in a period, the less valuable each additional unit becomes.

Question 23

What does the slope of Julia’s indifference curve represent?

Answer 23

The marginal rate of substitution (MRS) between consumption now and later

Question 24

what does it mean if MRS is high on Julia’s indifference curve?

Answer 24

She has little now and a lot later, so she values extra current consumption more.

Question 25

What does a falling MRS along an indifference curve mean?

Answer 25

Julia becomes less willing to give up future consumption for present consumption as she gets more of it now.

Question 26

What are the two sources of pure impatience?

Answer 26

Myopia – valuing present satisfaction more strongly; Prudence – uncertainty about being around in the future.

Question 27

What is pure impatience?

Answer 27

A personal preference for consuming now rather than later, regardless of smoothing or diminishing returns.

Question 28

What does it mean if Julia is at point A ($50 now, $50 later)?

Answer 28

She is smoothing consumption, but we can observe her impatience by how much she needs to be compensated to give up $1 now.

Question 29

What does a steep indifference curve mean?

Answer 29

Julia values current consumption more than future consumption—indicating impatience.

Question 30

What is a person's discount rate (ρ)?

Answer 30

A measure of impatience—how much more someone values consumption now versus later.

Question 31

How do we calculate someone's discount rate (ρ)?

Answer 31

ρ = MRS − 1, where MRS is the slope of the indifference curve.

Question 32

What two factors affect a person’s discount rate?

Answer 32

(1) Desire to smooth consumption (current situation), and (2) pure impatience (psychological trait).

Question 33

What happens at the tangency point between the indifference curve and the feasible frontier?

Answer 33

MRS = MRT → The discount rate equals the interest rate.

Question 34

What is the slope of the indifference curve (MRS)?

Answer 34

MRS = 1 + ρ

Question 35

When will Julia choose to borrow?

Answer 35

When her discount rate (ρ) is higher than the interest rate (r), i.e., MRS > MRT.

Question 36

What kind of indifference curve does Marco have when he wants to save?

Answer 36

Flat—he prefers to move consumption to the future.

Question 37

What is Marco’s feasible frontier before lending?

Answer 37

A flat line along the x-axis from 0 to 100—he can consume up to $100 now.

Question 38

What happens to Marco’s feasible set when he lends at 10%?

Answer 38

It expands, allowing future consumption of $100 × (1 + r) = $110.

Question 39

Where does Marco land on his highest utility curve when lending?

Answer 39

where MRS = MRT and he reaches a higher indifference curve.

Question 40

What is the slope of the investment line if return is 50%?

Answer 40

–1.5 (which is –(1 + return)).

Question 41

Why does Marco’s feasible set expand even more with borrowing and investing?

Answer 41

He uses his investment returns to justify borrowing against future income, gaining more consumption in both periods.

Question 42

Why does Julia start at a disadvantage compared to Marco?

Answer 42

She begins with no assets and has no investment opportunities, placing her on the borrowing side of the credit market.

Question 43

What are Marco’s four options ranked by total utility (combined consumption)?

Answer 43

L (Invest + Borrow): $80 now, $62 later → $142 total (Best) K (Invest only): $60 now, $60 later → $120 J (Lend only): $65 now, $39 later → $104 H (Store grain): $68 now, $26 later → $94 (Worst)

Question 44

What factors cause people to differ in which activity they engage in?

Answer 44

Their current vs. future income Whether they have investment opportunities Their level of pure impatience