2. Collapse of a Financial Market in a Partial Equilibrium (20 points total, 4 points for...

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2. Collapse of a Financial Market in a Partial Equilibrium (20 points total, 4 points for each subquestion) Assume the endowment economy, where a consumer's current income and future income are y - t and y' - t', respectively. Let r denote the real interest rate. Assume that borrowers and lenders face the same interest rate. (a) Now, suppose that the financial market collapses, making it impossible to borrow and save through the market. However, consumers can store goods at no cost from the current period to the future period. In the (C, C') space, draw the budget constraints before and after the collapse. (b) Draw the arbitrary indifference curves and denote the optimal choices of an initial lender (a consumer who was a lender before the collapse) before and after the collapse. What are the impacts on current consumption, future consumption, and saving? (c) Re-do (b) for an initial borrower. (d) Suppose that a government policy is introduced to mitigate the impact of the financial market collapse. The government acts as an intermediary and allows for saving and borrowing at the interest rate r. However, the government only allows borrowing up to B amount (B units in terms of a numeraire). State the new budget constraint and draw it. Does this policy benefit both the initial borrower and the initial lender? (Note: Subquestions (d) and (e) independently build on the original scenario given by the problem, with neither question building upon the other.) (e) Suppose that, even after the collapse, the government can borrow and lend in the international market at rater. The government's budget constraint is given by G+ = N N (t + 1+), G' 1+r where N denotes the population. For each person, the government gives a tax cut in the current period. The current-period tax changes from t to < t. Does this policy benefit both the initial borrower and the initial lender? 2. Collapse of a Financial Market in a Partial Equilibrium (20 points total, 4 points for each subquestion) Assume the endowment economy, where a consumer's current income and future income are y - t and y' - t', respectively. Let r denote the real interest rate. Assume that borrowers and lenders face the same interest rate. (a) Now, suppose that the financial market collapses, making it impossible to borrow and save through the market. However, consumers can store goods at no cost from the current period to the future period. In the (C, C') space, draw the budget constraints before and after the collapse. (b) Draw the arbitrary indifference curves and denote the optimal choices of an initial lender (a consumer who was a lender before the collapse) before and after the collapse. What are the impacts on current consumption, future consumption, and saving? (c) Re-do (b) for an initial borrower. (d) Suppose that a government policy is introduced to mitigate the impact of the financial market collapse. The government acts as an intermediary and allows for saving and borrowing at the interest rate r. However, the government only allows borrowing up to B amount (B units in terms of a numeraire). State the new budget constraint and draw it. Does this policy benefit both the initial borrower and the initial lender? (Note: Subquestions (d) and (e) independently build on the original scenario given by the problem, with neither question building upon the other.) (e) Suppose that, even after the collapse, the government can borrow and lend in the international market at rater. The government's budget constraint is given by G+ = N N (t + 1+), G' 1+r where N denotes the population. For each person, the government gives a tax cut in the current period. The current-period tax changes from t to < t. Does this policy benefit both the initial borrower and the initial lender?