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In: Economics

Suppose a person’s life is divided into two main blocks, periods 1 and 2. The consumer...

Suppose a person’s life is divided into two main blocks, periods 1 and 2. The consumer does not desire to perfectly smooth consumption over the two periods. In particular, preferences are such that c2 = 0.5 ∗ c1. Income in the two periods is equal to y1 = 500 and y2 = 1000, and income taxes are proportional τ1 = 50% and τ2 = 50%. The real interest rate is r = 0%.

(a) What is the present value of lifetime resources (PVLR)? What is the highest feasible consumption in the current period? What is the highest feasible consumption in the future period?

(b) Find the optimal consumption in each period (c∗1,c∗2) and the amount of saving/borrowing. Comment on your findings.

(c) What happens to the consumption and saving choices if the real interest rate is r = 100% and there are no taxes (τ1 = τ2 = 0%)? Comment on your findings.

So how to explain b and c?

Solutions

Expert Solution

Rahul Sunny answered 2 years ago
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