Figure 1. Inter-temporal Utility Maximization
The key implications from this simple two-period framework are:
1. The ratio of marginal utilities over consumption in the two periods
determines the choice of savings and investment.
2. The rate of return, r, is a key determining factor in the choice of
consumption or savings.
Logic Behind Borrowing
It is straight forward to adapt the model above to the situation of a consumer who would
prefer to borrow. Very low income individuals face a budget constraint so tight that C0 is
inadequate for sustaining a healthy life. In this instance, demand for loanable funds exists
to allow the budget constraint to be relaxed. For simplicity, consider an individual whose
current consumption is equal to income. Saving and investment for this individual is zero,
unless they borrow. If the individual borrows an amount B, then we can write the new
budget constraint as:
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