1. Consider a financial intermediary, such as a bank, that participates in the credit market. This intermediary borrows from some households and lends to others. (The loan from a customer to a bank often takes the form of a deposit account)

a. What interest rates would be the intermediary charge to its borrowers and pay to its lenders? Why must there be some spread between these two rates?

2. Discuss the effects on this years’ consumption, C1, from the following changes:

a. an increase in the interest rate, i,

b. a permanent increase in the real wage income, (w/p) * L,

c. an increase in current real wage income, (w/p)1 *L but no change in future real wage incomes

d. an increase in future real wage income, (w/p)1 *L for t=2,3,and so on.

e. A one-time windfall, which raises initial real assets, (Bo/P+Ko)

*Note: the number after the parenthesis (1) are subscript (small 1).