Suppose a consumer has y = 100 and y0 = 150. She pays t = 20...

Suppose a consumer has y = 100 and y0 = 150. She pays t = 20 and t0 = 30
in taxes. She faces an interest rate of 5% i.e. r = 0:05. Her utility function is
given by: U = ac + c0, where a > (1 + r).
(a) Assume that she cannot borrow. Determine her optimal choice of c and c0.
Show it in a diagram.
(b) Continue to assume that she cannot borrow. Now her current-period tax
is reduced to zero and future-period tax is increased such that the present
value of lifetime taxes does not change. Find her new optimal choice of c
and c0. Does Recardian Equivalence hold in this case? Why or why not?
(c) Finally assume that she does not face any borrowing constraint. Find her
optimal consumption bundle.

Expert Solution

Part C is similar to part A

Rahul Sunny answered 2 years ago

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