Consider two period models budget constraint as follows: Period 1: c1+ b + k + 1= e1

Consider two period model’s budget constraint as follows:

Period 1: c1+ b + k + τ1= e1

Period 2: c2+ τ2= f(k) + (1+r)bWhere c1and c2are consumption in period 1 and 2 respectively; b is bond; k is capital stock; τ1and τ2are lump sum tax in period 1 and 2 respectively; f(k) denotes production function; and r is the interest rate. 

a. Consider the consumer’s taxes increase by Δτ in the current period. How does this affect current consumption, future consumption and current savings?

b. The consumer’s taxes increase permanently, by Δτ in the current period and future period. Without drawing the diagram, determine the effects on current consumption, future consumption, and current savings.

c. State the Ricardian equivalence theorem.

d. Give four reasons that the burden of the government debt is not shared equally in practice

Answer rating: 100% (QA)

aAny increase in consumption equals an equivalent loss in saving for a given income hence consumptio... View the full answer