Macroeconomics

The Consumer’s Optimum With a Borrowing Constraint

When the consumer

faces a borrowing constraint, there are two possible situations. In panel (a), the con-

sumer chooses first-period consumption to be less than first-period income, so the

borrowing constraint is not binding and does not affect consumption in either peri-

od. In panel (b), the borrowing constraint is binding. The consumer would like to

borrow and choose point D. But because borrowing is not allowed, the best avail-

able choice is point E. When the borrowing constraint is binding, first-period con-

sumption equals first-period income.