1. Find the market equilibrium (or social planner's allocation) for this economy, i.e. the levels of...

  

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1. Find the market equilibrium (or social planner's allocation) for this economy, i.e. the levels of leisure and consumption for which the marginal rate of substitution is equal to the marginal rate of transformation. What is the household's utility in this equilibrium? The equilibrium you just found would attain in a frictionless non-monetary economy. We have seen, however, that if households can only spend their money a period after earing it, sustained inflation creates an inefficiency by driving a wedge between MRS,, and MRT unless the government follows the Friedman rule. If the nominal interest rate is R 0, then we have that MRT,=(1+ R)MRS, in equilibrium, resulting in too much leisure and too little consumption for the household compared to the efficient allocation. Assume that the nominal interest rate is about 6°o per year (4% real interest rate at 2% inflation). and that the relevant period length for the cash-in-advance constraint is a month, resulting in a period interest rate of R=0.5%. 1. Find the market equilibrium (or social planner's allocation) for this economy, i.e. the levels of leisure and consumption for which the marginal rate of substitution is equal to the marginal rate of transformation. What is the household's utility in this equilibrium? The equilibrium you just found would attain in a frictionless non-monetary economy. We have seen, however, that if households can only spend their money a period after earing it, sustained inflation creates an inefficiency by driving a wedge between MRS,, and MRT unless the government follows the Friedman rule. If the nominal interest rate is R 0, then we have that MRT,=(1+ R)MRS, in equilibrium, resulting in too much leisure and too little consumption for the household compared to the efficient allocation. Assume that the nominal interest rate is about 6°o per year (4% real interest rate at 2% inflation). and that the relevant period length for the cash-in-advance constraint is a month, resulting in a period interest rate of R=0.5%.

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