Ophelia says, If I could lend money at the rates I must pay to borrow, I would.And if I could borrow money at the rates I receive when I lend, I would again.But forsooth, although I spend, I neither borrow nor lend. Contrary to common belief, Ophelia is entirely rational.Draw a diagram to show how Ophelia's remarks can be consistent with rational behavior and smooth convex preferences if she pays a different interest rate when she borrows than she gets when she lends.Explain what happens in words.

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Zybrea Knight · Accepted Answer

Final Answer : Ophelia's budget between current and future consumption is kinked at the point where her consumption in each period equals her income.The highest indifference curve to touch her budget touches at the kink.The extensions of each of the lines that meet at the kink pass above this indifference curve for a distance.These lines are the lines she could move along if she could borrow at the lending rate and lend at the borrowing rate, respectively.

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