Inter-temporal Consumption

Introduction
• To understand consumption and investment
decisions made by individuals and firms
• To understand role of interest rates in
making consumption & investment
decisions
• The decision maker – Robinson Crusoe –
must choose between consumption now and
consumption in future.
• Investment is same as the decision not to
consume now.
2

1
 Introduction contd...
• Mr. Crusoe needs two types of information
– Understand his own subjective trade-off
between present and future consumption
– Understand feasible trade-off between present
and future consumptions that are
technologically possible (availability of
opportunities!).
• Answers
– To the first one is indifference curves and
utility
– To the second one is investment and production
3
opportunity sets

Financial General Equilibrium Model:

Irving Fisher (1867–1947)
Foundations of the Net Present Value
Rule:
Time: Captures Impatience : Think of Y as
the same good as X but one period later.

2
Fisher’s Impatient Theory: Interest

“ Impatient is a fundament attribute of human

nature. As long as people like to have things
today rather than tomorrow their will be a rate
of interest. Interest is, as it were, impatient
crystallized into a market rate”

Fisher’s Impatient Theory: Interest as Price

• Instead of thinking of money today for money

tomorrow Fisher thought of goods given up today
for good tomorrow.

• The real rate of interest is no more or less than the

(relative) value of good (consumption) today in
terms of good (consumption) tomorrow.

• Thus the rate of interest rate is the most important

price in the economy.

3
 Subjective Interest rates
• Price of deferred consumption
• Rate of return on investment
• Individuals having different subjective
interest rates will make different choices.

Market Interest rate

• Exists opportunities to exchange
consumption across time by borrowing or
lending in an economy
• Results in a single market interest rate that
everyone can use as a signal for making
optimal consumption/investment decisions
• Exchange economy use market prices to
allocate resources across time is superior to
an economy without price mechanism. 8

4
 Why Positive?

• The rate of interest is determined the same way

the relative price of apples and oranges is
determined, by supply and demand.
• The rate of interest is positive because impatient
people prefer goods today to good tomorrow and
because there will probably be more good
tomorrow than today.

Inter-temporal framework
• For inter-temporal consumption choice, x becomes current
consumption (C0) and y becomes future consumption (C1). That
means, happiness depends on two things: current and future
consumption.

C1

U2
U1
U0
10
C0

5
 Utility function
The consumer’s preferences are represented by an intertemporal utility function
u(c0,c1).
The utility maps consumption pairs into real numbers, i.e., the larger the
number the better the consumption pair.
Diminishing marginal utility of consumption

U(C0)
Observations:
• Marginal Utility >0
• DMUs

Total Utility of Consumption C0

U(C0,C1)

U(C1)
Indifference Curves:
Provides various
combinations of C0 and A
C1 such that utility is
same.
B
C1

U(C0)

Trade offs between C0 & C1

C0

6
 MRS: MRS decreasing:

C1 MRS01A  MRS 01B

MRSCC10 
C0 u  cons tan t rA  rB
 (1  ri )

Note : C1=C0(1+ri)

13

SRTP
Slope of the line:
How many extra units of consumption
tomorrow must be received to give up one
unit C0.
Change in C1 C1 Point A has a higher SRTP than B.

A
Change in C1
B

1 unit 1 unit C0

7
 SRTP is higher at
C1 A than B Slope at B is MRS between C0 & C1

A D
B

C0

Indifference curves representing the

time preference of consumption.

SRTP and Utility

• SRTP is the relative valuation placed on present
consumption compared with its valuation in future.
• If ri is high, the price of consuming today is high because
the agent is foregoing a high rate of return.
• In other words, the higher the time preference, the higher
the discount placed on future consumption.
• Just as Rs1 from now does not worth Rs1 today, 1 unit of
utility that one can get next period does not worth 1 unit of
utility today. The individual discounts 1 unit of utility next
period by her subject rate of time preference.

1
U (C0, C1)  U (C0)  U (C1)
1 ri
16

8
 (Im)patience and discounting
• 1/(1+ri) is the discount factor, i.e. the factor at which future
consumption is discounted compared to current consumption. The
assumption 1/(1+ri ) < 1 means that households always prefer to
consume c this period than exactly the same amount next period.
• Patience is related to the discount factor. The lower the discount factor
the lower is the degree of patience of a consumer: consumers with low
discount factor are impatient and they prefer to consume immediately.
• For example, in the extreme case where ri = 0 agent consume all their
income in period 0 and C1 = 0 as they do not value the future.

17

Saving decisions
• Suppose the consumer stands at date zero and makes choices that will allocate
income and consumption across two dates t = 0 and 1, that we refer to as now
and then respectively.
• The consumer is endowed with some income now and then. Let y=(y0,y1)
denote the income pair, similarly let c=(c0,c1) denote the consumption pair;
each pair represents currency now and then.
• Suppose the consumer can borrow and lend at the known interest rate r. Then
the consumer selecting a consumption pair also makes a savings decision s0 =
y0 − c0; the savings choice yields (y0 − c0)(1+r) rupees then. The consumer
must make these consumption choices consistent with a budget constraint:
c y
c0  1  y0  1
1 r 1 r
c1 y0(1+r) + y1

y1 y
y0 + y1/(1+r)

y0 c0
18

9
 Budget constraint
• Note that (1+r) is the absolute value of the slope
of the budget constraint and corresponds to the
increase in consumption then from each saved
now. A greater income either now or then yields a
higher budget line through the new income pair.
• A greater interest rate yields a steeper budget line,
since giving up a unit of consumption now would
permit even more consumption then.

19

Optimal consumption
• Recall that an individual maximizes his happiness subject to constraints. What
are the constraints?
• It depends on the options available for the individual to allocate his wealth
across different time periods.
• We study two options: [1] Production opportunity and [2] participation of
capital market.
• We assume the individual has endowment of Y0 and Y1 in the current and
future periods respectively. So, we can plot the endowment point on the
diagram.
• Constraint A: “With no wealth allocation across periods”, his utility is U1.
C1

C*

Y1 I2
I1
20
Y0 C0

10
 Optimal consumption
• The individual’s choice problem may be
characterized as a constrained maximization
problem.
• The consumer selects the consumption pair
to maximize u(c0,c1) subject to c  c  y  y 0
1
0
1
1 r 1 r

21

Solution
• The Lagrange function for this problem is
 c1 y1 
L ( c 0 , c1 ,  )  u ( c 0 , c1 )    c 0   y0  
 1 r 1 r 
FOC
L u
    0 .....( 1 . 1 )
c0 c0
L u 1
   0 ....( 1 . 2 )
 c1  c1 1 r
L y1 c1
 y0   c0   0 ....( 1 . 3 )
 1 r 1 r 22

11
 Solution
• The solution to this problem is
demonstrated in Figure. The marginal rate
of substitution is the ratio of the marginal
utility of consumption now to the marginal
utility of consumption then. From (1.1) and
(1.2) it follows that
u
c0 
MRS    1 r
u 1
c1 
1 r 23

Interpretation
• Note that at the consumption bundle c∗, the
consumer’s marginal rate of substitution
equals SRTP as well as one plus interest
rate i.e.
MRS = SRTP = (1+ri)
• The optimality condition has a simple
interpretation; it says that at the margin c∗
the individual values consumption now in
terms of consumption then at its opportunity24
cost.

12
 Production opportunity
• Allows a unit of savings/investment to be turned into more
than one unit of future consumption
• We assume that each individual in the economy has a
schedule of productive investment opportunities that can
be arranged from highest rate of return down to the lowest.
• An individual will make all investments in productive
opportunities that have rates of return higher than his or
her SRTP, ri

25

Simple Investment
Opportunities Invest opportunities
A are arranged from the
highest to lowest rate
of return.

Π(I0) B Observation: DMR

I0
X
Total Investment

Mr. Crusoe’s schedule of investment. He will

select all investments that have rates of return
higher than SRTP

13
 Project Investment Rate of Return

A 1,000,000 8%
B 1,000,000 20%
C 2,000,000 4%
D 3,000,000 30%

Graph the production opportunity

set in a Co & C1 framework and
verify it is close to concave (why?)

Cum Output
Project ROA (1+r) Investment Capital (C_1)
D 1.3 3 3 3.9
B 1.2 1 4 1.2
A 1.08 1 5 1.08
C 1.04 2 7 2.08

Total 8.26

Production Opportunity Set

C_1 is obtained as 8.26 – 2.08 = 6.18

10

8 0, 8.26
C_1 is obtained as 6.18 – 1.08 = 5.1
6 2, 6.18
C_1

3, 5.1 C_1 is obtained as 5.1 – 1.2 = 3.9

4 4, 3.9

2
C_1 is obtained as 3.9 – 3.9 = 0
0 7, 0
0 2 4 6 8
C_0

14
Marginal Rate of Transformation
• Rate at which a Re of consumption
foregone today is transformed by productive
investment into a Re of consumption
tomorrow.

29

MRT: MRT increasing:

ui [W ( I1 )]
MRT01i  MRT01A  MRT01B
ui [W ( I 0 )] B
 (1  ri ) rA  rB

30

15
 INVESTMENT OPPORTUNITIES
Marginal Rate of Return
(Future consumption – future endowment)
Production Opportunity Set (POS)
C1

A
Low rates of
return
High
High rates of
return
y1
endowment
Low point

B
I0 I1 Total investment y0 C0
(current endowment – current consumption)
I0
I1

Production Opportunity
• Total investment in the current period is equal to current period endowment
minus current consumption (i.e., Investment = Y0-C0)
• With this in mind, we can plot the constraint on the C0-C1 space.
• We call this constraint the production opportunity set (POS).
• The slope of the POS is now called the Marginal Rate of Transformation
(MRT) offered by the production/investment opportunity set.
• Investment (or dis-investment) means the individual can move its consumption
point along POS.
• Point A is the initial endowment solution
C1 Slope: Rate at which one unit
of consumption foregone
today is transformed by
productive investment into
future consumption (MRT).

Y1 A
32
Y0 C0

16
 PUTTING TOGETHER THE POS AND PREFERENCES

C1
In the absence of production
the individual would be forced
to consume at the endowment
point

y1
The endowment U0
point

y0 C0
33

PUTTING TOGETHER THE POS AND PREFERENCES

C1
Small vertical arrow
- amount needed to be equally well
off in utility terms (ρ)
Large vertical arrow
- amount of return to deferring consum
today and undertaking investment

y1 0
1
U0

y
0 C
Individuals will make all investments in the production opportunity set0
34
that have rates of return higher than his or her subjective rate of time preference

17
 PUTTING TOGETHER THE POS AND PREFERENCES
This is the point where
C1 MRT = MRS

(slope of = (slope of
POS) indifference
curve)

y1 0 U1
The endowment
point U0
I0
y0 C0
Message: Production opportunities allow individuals to achieve a higher 35
level of utility – i.e. Move to U1 > U0

Benefits of Production Opportunities

• In the absence of investment opportunities, individuals are
constrained to consume at his endowment point
• Investment opportunities expand the consumption set
• Individuals are therefore better off
• At point 0,
• MRT > MRS [the slope of POS] > [slope of utility function]

• [The return one obtains > [return required by the

from investing] individual to forego
current consumption]
=> Optimal action: Increase the amount investing until
• At point *, MRT=MRS, and I0 is the optimal level of
investment
36

18
 C1 Slope: Rate at which one unit of
Slope= -(1+ri) consumption foregone today is
transformed by productive investment
into future consumption (MRT).

B
P1= C1

U2

y1
U1

A
P0= C0 y0 C0

Mr. Crusoe, therefore makes his decision by using a

simple rule:

MRS = MRT = SRTP = -(1+ri)

Process: Mr. Crusoe starts with an initial endowment and

compares his SRTP with the MRT. If the rate on
investment is higher he gains by making investment (Y0-
C0). He finally gets to B, where MRT=SRTP.

19
A few important observations:

1. At B, Mr.Crusoe’s consumption in each time period is

exactly equal to the output from production.

2. Individuals with same endowment and the same

investment opportunity set may end up with different
investments as they have different Indifference Curves.

Individual 1 Individual 1 has lower SRTP

C1

Individual 2
y1

y0 C0
1
MRS 01  MRT011  MRS 012  MRT012
Individual 1 prefers consuming more at C1
Individual 2 prefers consuming more at C0

20
 Capital market
1. Inter-temporal exchange of consumption bundles will be
represented by the opportunity to borrow or lend unlimited
amounts at r, a market determined rate of interest .
2. Capital market facilitate the transfer of funds between
lenders and borrowers.
3. Interest rate is positive: Any amount of funds lent today will
return interest plus principal at the end of the period.

X1 = X0 + r X0 = X0 (1+r)

Capital market
• Now, instead of one individual, let’s assume there are many individuals in the
economy. Some are lenders, while others are borrowers. Among them, there
are opportunities to borrow and lend at the market-determined interest rate (r).

Constraint: No production opportunity. But individuals can lend/borrow at r.

• We can then graph the borrowing and lending opportunities along the capital
market line.
• Now, we introduce the concept of wealth. Wealth of an individual is the
present value of his current and future endowment. Thus,
C1 W0 = Y0 + Y1/(1+r)

W1 = Y0(1+r) + Y1

Capital market line with Slope = -(1+r)

Y1 A
42
Y0 W0 C0

21
Consumption Decision with Capital Market
C1
Capital Market Line: Slope = -(1+r)
W1

C*1
U2
A
y1 U1
SRTP= -(1+ri)
C0
C*0 y0 W0

43

Equation for the Capital market Line:

1. W0 = Y0 + Y1/(1+r)

2. W0 = C*0 + C*1/(1+r)

=> C*1 = W0 (1+r) - (1+r) C*0

C*1 = W1 - (1+r) C*0

intercept slope

Observation: Moving along the capital line does not change one’s
wealth, but it does offer different pattern of consumption.

22
 Production and capital market
Constraint: Individuals can now borrow/lend at r & invest in production opportunities.
• With only production opportunity, the individual achieve U2 only. But if capital
market is introduced, he can actually do better.

• At point B , the individual can borrow more money at rate r from the capital market,
and be able to invest more and get return higher than r. At B, the borrowing rate
(CML slope) is less than the rate of return on the marginal investment (slope of POS).

• Further investment returns more than the cost of borrowed funds, individual will
continue to invest until C , where the return on the marginal investment is equal to the
market interest rate r.

• At C the present value of wealth is W*0 = P0 + P1/(1+r) generated from the

production (P0, P1) which is larger than W0.

• Furthermore, individual can reach any point on the market line (why?). Since SRTP at
C is greater than the market return, he will consume more than P0, which is the current
payoff from the production. By borrowing, he reaches point D on CML. Optimal
consumption is found as (C*0, C*1) where subjective time preference just equals
market rate of return. Utility increases from U1 to U3.

• U1(initial endowment) < U2(Robinson Crusoe production solutions) < U3 45

(Exchanged economy solution)

Consumption & Investment Decision with Capital

Market

Step 1: Production economy

B
P1= C1
U2

y A U1

P0= C0
y
0

23
Consumption & Investment Decision with
Capital Market
Step 2: Mr. Crusoe with capital market

P1
C
C* D U3
1 B U2
Market Line
A
y1 U1

P0 C*0 y0 W0 W*0

Consumption & Investment Decision

with Capital Market
1. Decision process takes place in two separate &
distinct steps.
2. Select the optimum production decision by taking
project until MRT equals the market rate r.
MRT = - (1+r)
3. Select the optimum consumption by borrowing or
lend along the capital market line to equate SRTP
with the market rate of return.
MRS = - (1+r)

24
 Fisher’s Separation Theorem:
Given perfect and complete capital market, the
production decision is governed solely by an
objective market criterion (represented by max.
wealth) without regard to individual’s subject time
preferences that enter into their consumption
decision.
In equilibrium, the MRS for all investors is equal to the market rate of
interest, and this in turn is equal to MRT for productive investment.

MRSi = MRSj = - (1+r) = MRT

The Inter-temporal Consumption Choice

Consumption

*
* *
U’ * U’’’
U’’
0 Production
U0 0 U0 0 U0

Production alone Capital Market Alone Both Capital Market & Production

Preferences determine There is no production, Capital market line objectively

Production and and preference determine determines production with the
Consumption Point consumption market interest rate,
(same point) And individual preference
subjectively determines
consumption with his rate of time
preference

50

25
 The Inter-temporal Consumption Choice

Consumption
Consumption Consumption

*
* *
U’ * U’’’
U’’
0 Production
U0 0 U0 0 U0

Production alone Capital Market Alone Both Capital Market & Production

Preferences determine There is no production, Capital market line objectively

Production and and preference determine determines production with the
Consumption Point consumption market interest rate,
(same point) And individual preference
subjectively determines
consumption with his rate of time
preference

51

Fisher Separation Theorem

• As the graph below shows, with two different individuals that differs only in their
subjective preferences, given the same opportunity set, both of them would choose the
exact same point of production regardless of the difference of their preferences.

C1

Individual 2
P*1

Individual 1
Y1

52
P*0 Y0 W*0 C0

26
 1. In the figure below, the downward sloping straight line connecting the points (0,5) and (4,0)
represents the opportunities for investment in the capital market, and the downward sloping curved
line connecting the points (0,4) and (2.6,0) represents the opportunities for investment in physical
capital (e.g. plant and machinery). The only asset at time 0 is Rs2.6 million in cash (initial
endowment). There is no additional endowment present at time 1. Please answer the following
questions related to the figure:

a. What is the interest rate, r, and what is the slope of the capital market line?
b. How much should be invested in physical capital (plant and equipment), and how much will this
investment be worth next year?
c. What is the present value (PV) and net present value (NPV) of this investment?
d. What is the optimal consumption at times 0 and 1?
e. How much is borrowed or lent at time 0

Rs. Mn, Year 1

Rs. Mn, Year 0 53

FISHER SEPARATION THEOREM

• Given perfect and complete capital markets (frictionless), the
production decision is governed solely by an objective market criterion
(represented by maximizing attained wealth) without regards to
individual’s subjective preferences that enter into the consumption
decision.

• This is extremely important for corporate finance

• regardless of the shape of individual investor’s indifference

curve of a firm, every investor of that firm will direct the
manager to the same production decision
- The investment decision is independent of individual
preferences

54

27
 Consider two individuals
C1 Both individuals 1 and 2
make the same investment
decision: both produce at *,
and by using capital markets,
borrow or lend to achieve
their own optimum consumption point

That is, regardless of the shape

Individual 2
(stronger preference
for future consumption)
of their utility functions, they make
exactly the same production decision
* In math:
MRS1 = MRS2 = -(1+R) = MRT

Individual 1
(stronger preference
for current consumption)

C0
55

The Separation of C and I decisions

• Both investors 1 and 2 will direct the manager of the firm to choose point (*)
• The investors simply takes the output of the firm and adapts it to their own
subjective time preferences by borrowing and lending in the capital market
• The optimal production decision is separated from individuals utility
preferences (thus individual investors are unanimous (Unanimity principle))
ROLE OF CAPITAL MARKETS
• capital markets allow the efficient transfer of funds from lenders to borrowers
• Individuals who have insufficient wealth to take advantage of all their
investment opportunities that yield rates of return higher than the market rate
are able to borrow funds and invest more than they would without capital
markets i.e., funds can be efficiently allocated from individuals with few
production opportunities and great wealth to individuals with many
opportunities and insufficient wealth
• All borrowers and lenders are better off than in the absence of capital markets
INVESTMENT DECISION
• The objective of the firm is to maximize the wealth of its shareholders.
• This is the same as [maximizing the present value of the shareholders lifetime
Consumption] = [maximizing the price per share per stock]
56

28
 How to max shareholder’s wealth?
• We again uses Fisher Separation Theorem
• Given perfect and complete capital markets, the owners of the firm
(shareholders) will unanimously support the acceptance of all projects until
the least favourable project has return the same as the cost of capital.
• In the presence of capital markets, the cost of capital is the market interest
rate.
• The project selection rule, i.e., equate
marginal rate of return of investment = cost of capital (market interest rate)
• Is exactly the same as the net present value rule:
Net Present Value Rule
• Calculate the NPV for all available (independent) projects. Those with
positive NPV are taken.
At the optimal:
NPV of the least favourable project ~= zero
• This is a rule of selecting projects of a firm that no matter how individual
investors of that firm differ in their own opinion (preferences), such rule is
still what they are willing to direct the manager to follow.
57

Implications of Fisher Separation

Theorem
• The separation principle implies that the maximization of the
shareholder’s wealth is identical to maximizing the present value of
lifetime consumption
• Since borrowing and lending take place at the same rate of interest, then
the individual’s production optimum is independent of his resources
and tastes
• If asked to vote on their preferred production decisions at a
shareholder’s meeting, different shareholders will be unanimous in their
decision
•  unanimity principle
• Managers of the firm, as agents for shareholders, need not worry about
making decisions that reconcile differences in opinion among
shareholders i.e there is unanimity
• The rule is therefore
– take projects until the marginal rate of return equals the
market interest rate = taking all projects with +ve NPV
58

29
 Marketplaces and Transaction
Costs
• In absence of transaction costs, there is no
need for a central location for exchange. i.e.
there is no need for a marketplace per se.
• Consider an economy with N producers.
Each producing a specialized product and
consuming a bundle of N consumption
goods.

59

Transactions Costs and

Capital Market
Case 1: 5 individual with
2 5 different commodities.

1 3

4
5 individuals = 10 trips 10T cost
5

30
 Transactions Costs and Capital Market
1. With nontrivial transaction cost, financial intermediaries
and market place will provide a useful service.

D
FIs
A C

B
2. Intermediaries will ask for a premium: Borrowing rate
will be typically higher than the lending rate.

Transactions Costs and Fisher’s Separation Theorem

Individual B
C1 Lending rate

PB1 B
PA1 A
Borrowing rate
Individual A

C0
PB0 PA0

31
 Principal-Agent Problem
• Principals = Shareholders, Agent = Manager of the firm.
• Ownership ≠ control, so there is no reason to believe that managers
will always act in the best interest of the shareholders (Consider all the
accounting scandals)
- If the shareholders can costlessly monitor management decisions, they
can be sure that management really does make every decision in a way
that maximizes their wealth
- In reality, owners must incur non-trivial monitoring costs in order to
keep the manager in line => owners (shareholders) face a trade-off
between monitoring costs and forms of compensation that will cause
the agent to always act in the owners interest

- Fisher separation holds only with strong assumptions: (I.e frictionless

markets)
-  I.e can costlessly monitor managers
-  decisions always made to maximize value of the firm

63

Numerical Example
• Assume individuals can borrow and lend, but no production
• Suppose that the utility function for consumption is
U = log(C0) + [1/(1+ )] log(C1)
• The individual’s wealth is given by the equation
• W = y0 + [1/(1+R)]y1
• where R is the rate of interest and
•  is the subjective rate of time preference
• If an individual is to maximize utility, then we know that the present
value of consumption must equal wealth: W = y0 + [1/(1+R)]y1

• Derive the optimal consumption paths, assuming

a) W=100, R=10%,  =10%
b) W=100, R=5%,  =10%
c) W=100, R=10%,  =5%

64

32
 The Optimization Problem
• Set up the constrained optimization problem
• L = log(C0) + [1/(1+ )] log(C1) + [ W – C0 – C1/(1+R)]
• The first order conditions
• L/C0 = (1/C0) -  = 0   = 1 / C0
• L/C1 = (1/(1+ )) (1/C1) - /(1+R) = 0   = [(1+R)/(1+)] (1/
C1)]
• [1 / C0] = [(1+R)/(1+)] (1/ C1)]
• C0* = [(1+ )/(1+ R)] C1*
C1
– If  = R  C0* = C1*
– If  > R  C0* > C1*
– If  < R  C0* < C1*
C1*
U
C0
C0* 65

Optimal Consumption Paths

• Solve for the following three cases
• a) W=100, R=10%,  =10%
• C0 = (1.10/1.10)C1  W = C0 + C1 /(1+R) = 100
C0* = C1* = C* = 52.38
• b)W=100, R=5%,  =10%

• c)=100, R=10%,  =5%

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 Homework
• Graphically demonstrate that in a world of certainty, the
introduction of capital market will benefit TWO different
individuals with different preferences. In the graph, show
that one of them is a lender, while the other is a borrower.

• Graphically demonstrate the Fisher separation theorem for

the case where an individual ends up lending in financial
markets. Label the following points on the graph: initial
wealth, W0; optimal production/investment (P0,P1); optimal
consumption (C*0,C*1) ; present value of final wealth W*0 .

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Storage
• For an individual to benefit from storage (assuming non-perishable
goods and no storage costs,
• [slope of the indifference curve] < 1 (in absolute value)
• dC1/dC0 = -(1- ) [U'(C0)/ U'(C1)]
• and assuming log utility:
• dC1/dC0 = [-(1- )](1/C0) / (1/C1) = [-(1- )]C1/C0
• In other words, simple storage makes an individual better off if
• (1+ ) C1/C0 < 1 or (1+ ) < C0/C1
• Again, this assumes log utility i.e. storage may be beneficial if C0 is
high relative to C1

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