Suppose that the government introduces a tax on interest earnings . That is, borrowers face a...

Suppose that the government introduces a tax on interest earnings . That is, borrowers face a real interest rate of r before and after the tax is introduced , but lenders receive an interest rate of(1-x) on their savings, where x is the tax rate . Therefore , we are looking at effects of having x increase from zero to some value greater than zero , with r assumed to remain constant .

A. Show the effects of the increase in the tax rate on a consumer’s lifetime budget constraint.

B. How does the increase in the tax rate affect the optimal choice of consumption ( in the current and future periods) and saving for the consumer? Show how income and substitution effects matter for your answer, and show how it matters whether the consumer is initially a borrower or a lender.

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Rahul Sunny answered 1 year ago

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