Figure 9.11: Summary of Marco's Financial Options

Figure 9.10 (Marco Gets a Loan): Marco's Choice When He Can Invest and Borrow

An individual has $200 available today and no income expected in the future. They have access to a one-time investment opportunity that yields a 40% return, and they can also borrow funds at a 15% interest rate. They decide to implement a strategy where they invest their entire $200 today and then immediately borrow against the future proceeds to maximize their current consumption. What is the maximum amount they can consume today, assuming they must be able to fully repay the loan with their investment earnings in the future?

An individual has an investment opportunity that yields a 20% return and can borrow money at an interest rate of 25%. For this individual, a strategy of investing their entire endowment and then borrowing against the future proceeds will expand their feasible consumption possibilities compared to only having the investment option.

Evaluating a Farmer's Financial Strategy

A company in the highly competitive smartphone market launches an extensive advertising campaign. The campaign focuses on the phone's unique camera features, sleek design, and association with a trendy lifestyle, rather than its price. Subsequently, the company raises the price of its phone by 8%, but experiences only a 3% drop in sales. In contrast, a competitor who raises their price by the same amount sees a 15% drop in sales. Which economic principle best explains this difference in outcomes?

A coffee grower has an entire harvest of beans worth $50,000 today. They have two options: sell the beans now for immediate cash, or roast and package them, which will make them worth $80,000 in one year. The grower can also secure a loan at an annual interest rate of 10%. If the grower decides to process the beans for their future value and simultaneously takes a loan for immediate expenses, what is the fundamental reason this combined approach can lead to a better outcome than simply selling the beans now or waiting a year to consume the profits?

Evaluating a Financial Strategy

Investment Decision Scenario

Calculating Optimal Consumption Across Time

An individual has an endowment consisting entirely of consumption available today. They discover a productive investment opportunity that yields a 50% return, available in the future period. They also have access to a credit market where they can borrow at a 10% interest rate. If this individual chooses to invest their entire endowment and then borrow against the future returns to fund current consumption, how does this combined strategy alter their feasible consumption frontier compared to a situation where they could only invest?

Calculating Future Consumption with a Combined Strategy