Consider a consumer’s consumption-saving decision in a two-period model. Suppose that the real interest rate is...

Consider a consumer’s consumption-saving decision in a two-period model. Suppose that the real interest rate is r. This consumer’s current income is y and the future income is y’ . The government imposes lumpsum taxes t and t’ in the current period and future period, respectively. In addition, the government subsidizes savings with rate q: the consumer needs to pay 1 /(1+q) to save one unit of consumption. That is, the budget constraint of the current period is c + s/( 1 + q) = y − t.

(a) (10 points) Derive the lifetime budget constraint. Graphically illustrate this person’s budget constraint, endowment point, and optimal choice. Assume that this consumer is the lender (saver).

(b) (10 points) What will be the effects of decreasing q on (c, c’ , s), respectively? Assume that this consumer remains as the lender, and the substitution effects are dominating. Explain.

Expert Solution

In this solution, we have considered the subsidized savings and solve the sum with two period model.

Rahul Sunny answered 2 hours ago

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