Imagine a government that exists for two periods. In both periods the government receives tax revenue of $50. The government begins time Period 1 with an asset that is worth $100. Due to an emergency, government spending is $150 in Period 1. If the government accumulates debt in Period 1, they will have to repay that debt at an interest rate of 2% in Period 2. The government’s asset may be sold in either Period 1 or Period 2. Assume that the asset appreciates in value by 3% from Period 1 to Period 2. Assume that the asset must be sold in Period 2 if it is not sold in Period 1. (30 points)

a) Calculate the government’s debt at the beginning of Period 2 if they sell their asset in Period 1. (5 points)

b) Assuming that the government is unable to accumulate debt in Period 2, what is the maximum level of government spending that can be sustained in Period 2 if the asset was sold in Period 1? (5 points)

c) Calculate the government’s debt at the beginning of Period 2 if they do not sell their asset in Period 1. (5 points)

d) Continuing to assume that the government is unable to accumulate debt in Period 2, what is the maximum level of government spending that can be sustained in Period 2? (5 points)

e) Is the government’s Period 2 potential spending higher if they sell their asset in Period 1 1 or Period 2? Explain the intuition behind your result. (10 points)

Answer rating: 100% (QA)

Answer a The Governments debt at the beginning of period 2 0 b The maximum level of government spend... View the full answer