borrowers and savers/lenders Flashcards
What is money?
A medium of exchange like bank notes or deposits, accepted for payment because it can be used to purchase goods and services.
How does money differ from barter?
Barter is direct exchange (e.g. apples for oranges), while money allows indirect exchange since it’s accepted by everyone.
What makes money effective in modern economies?
Trust—people believe others will accept money in exchange for goods and services.
How does money facilitate exchange over time?
It allows purchasing power to be stored and transferred, enabling delayed payments.
What is wealth?
The maximum you could consume without borrowing, after paying off debts and collecting money owed to you.
What is income?
The flow of money received over time from earnings, investments, or government transfers.
What type of variable is income?
A flow variable—measured over time.
What type of variable is wealth?
A stock variable—measured at a specific point in time.
What is net income?
Disposable income minus depreciation.
What does borrowing allow us to do in terms of consumption?
It allows us to bring consumption forward in time—consume more now and less later.
What is the opportunity cost of consuming more now?
Consuming less later.
How do borrowing and lending affect spending over time?
They let us rearrange when we spend our money—shift purchasing power between periods.
What is Julia’s repayment formula?
Repayment = Principal × (1 + r)
If Julia borrows $91 at 10% interest, how much does she repay?
$100 → 91 × (1 + 0.1)
How is the interest rate calculated?
Interest rate = (Repayment / Principal) - 1
What happens if the interest rate increases (e.g., to 78%)?
Julia can borrow less now (only $56), and her feasible frontier shifts inward.
What is the marginal rate of transformation (MRT) in this context?
MRT = 1 + r → It’s the rate at which future goods must be given up for present goods.
What are the two reasons Julia may be impatient?
(1) She prefers to smooth her consumption over time, and (2) she may just be an impatient person.
Why is there a conflict of interest between borrowers and lenders?
Borrowers prefer lower interest rates; lenders benefit from higher rates.
What is consumption smoothing?
Choosing to spread consumption evenly over time to avoid consuming everything in one period and nothing in another.
What is the law of satiation of wants?
The idea that the value of additional consumption decreases as more is consumed—also called diminishing marginal returns to consumption.
What is diminishing marginal returns to consumption?
The more you consume in a period, the less valuable each additional unit becomes.
What does the slope of Julia’s indifference curve represent?
The marginal rate of substitution (MRS) between consumption now and later
what does it mean if MRS is high on Julia’s indifference curve?
She has little now and a lot later, so she values extra current consumption more.
What does a falling MRS along an indifference curve mean?
Julia becomes less willing to give up future consumption for present consumption as she gets more of it now.
What are the two sources of pure impatience?
Myopia – valuing present satisfaction more strongly;
Prudence – uncertainty about being around in the future.
What is pure impatience?
A personal preference for consuming now rather than later, regardless of smoothing or diminishing returns.
What does it mean if Julia is at point A ($50 now, $50 later)?
She is smoothing consumption, but we can observe her impatience by how much she needs to be compensated to give up $1 now.
What does a steep indifference curve mean?
Julia values current consumption more than future consumption—indicating impatience.
What is a person’s discount rate (ρ)?
A measure of impatience—how much more someone values consumption now versus later.
How do we calculate someone’s discount rate (ρ)?
ρ = MRS − 1, where MRS is the slope of the indifference curve.
What two factors affect a person’s discount rate?
(1) Desire to smooth consumption (current situation), and (2) pure impatience (psychological trait).
What happens at the tangency point between the indifference curve and the feasible frontier?
MRS = MRT → The discount rate equals the interest rate.
What is the slope of the indifference curve (MRS)?
MRS = 1 + ρ
When will Julia choose to borrow?
When her discount rate (ρ) is higher than the interest rate (r), i.e., MRS > MRT.
What kind of indifference curve does Marco have when he wants to save?
Flat—he prefers to move consumption to the future.
What is Marco’s feasible frontier before lending?
A flat line along the x-axis from 0 to 100—he can consume up to $100 now.
What happens to Marco’s feasible set when he lends at 10%?
It expands, allowing future consumption of $100 × (1 + r) = $110.
Where does Marco land on his highest utility curve when lending?
where MRS = MRT and he reaches a higher indifference curve.
What is the slope of the investment line if return is 50%?
–1.5 (which is –(1 + return)).
Why does Marco’s feasible set expand even more with borrowing and investing?
He uses his investment returns to justify borrowing against future income, gaining more consumption in both periods.
Why does Julia start at a disadvantage compared to Marco?
She begins with no assets and has no investment opportunities, placing her on the borrowing side of the credit market.
What are Marco’s four options ranked by total utility (combined consumption)?
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)
What factors cause people to differ in which activity they engage in?
Their current vs. future income
Whether they have investment opportunities
Their level of pure impatience
