B1(b) Show consumption c1 and c2 (you can use algebraic or graphical methods). In the answer, you should discuss whether a1 ≥ 0 or a1 < 0 and provide an economic interpretation. What determine(s) the sign of a1 and why?Explain how a credit constraint can be modeled by a1 ≥ 0 and under this constraint how does your answer to B1(b) change? How does it change if there is a banking markup such that the borrowing interest rate is above the interest rate of r = 0 assumed earlier? Hint: try to relate your reasoning to the permanent income hypothesis.Suppose a0 = A0/P1 where A0 ≥ 0 denotes the savings in nominal terms. Consider a supply-side shock that leads to a surprise significant increase of the price level only in period 1. Should the government change its tax plan if a1 ≥ 0 is imposed? Term 1 Section [25'] Consider the two-period household-maximization model discussed inclass. The model is modified in order to look at applications including credit constraints,interest-rate markups, and taxation. A representative household lives for two periods andmaximizes utility of consumption in period 1 and in period 2. The utility is represented bylog (c) where c denotes consumption. Assuming no discounting between period 1 and period 2.The maximization problem for the representative household can be written asmax{log c1 + log c2}C1 + a1 = Y1 – T1 + (1+r)aoC2 = Y2 – T2 + (1+r)a1where y1 and y2 denote income levels in period 1 and period 2, T1 and T2 are taxes in the twoperiods, and ao and a1 denote the assets of the households in each period. ao is exogenouslygiven. Assume the interest rate r =0, and the government can borrow or save at the sameinterest rate so that its present-value budget constraint is given by9i + 92 = T1 + T2where g1 and 92 are exogenous government expenditures in the two periods.

Making intertemporal judgments involves balancing the present with future spending. People have to…

Answered: B1(b) Show consumption c1 and c2 (you…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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B1(b) Show consumption c1 and c2 (you can use algebraic or graphical methods). In the answer, you should discuss whether a1 ≥ 0 or a1 < 0 and provide an economic interpretation. What determine(s) the sign of a1 and why?

Explain how a credit constraint can be modeled by a1 ≥ 0 and under this constraint how does your answer to B1(b) change? How does it change if there is a banking markup such that the borrowing interest rate is above the interest rate of r = 0 assumed earlier? Hint: try to relate your reasoning to the permanent income hypothesis.

Suppose a0 = A0/P1 where A0 ≥ 0 denotes the savings in nominal terms. Consider a supply-side shock that leads to a surprise significant increase of the price level only in period 1. Should the government change its tax plan if a1 ≥ 0 is imposed?

Term 1 Section [25'] Consider the two-period household-maximization model discussed in
class. The model is modified in order to look at applications including credit constraints,
interest-rate markups, and taxation. A representative household lives for two periods and
maximizes utility of consumption in period 1 and in period 2. The utility is represented by
log (c) where c denotes consumption. Assuming no discounting between period 1 and period 2.
The maximization problem for the representative household can be written as
max{log c1 + log c2}
C1 + a1 = Y1 – T1 + (1+r)ao
C2 = Y2 – T2 + (1+r)a1
where y1 and y2 denote income levels in period 1 and period 2, T1 and T2 are taxes in the two
periods, and ao and a1 denote the assets of the households in each period. ao is exogenously
given. Assume the interest rate r =
0, and the government can borrow or save at the same
interest rate so that its present-value budget constraint is given by
9i + 92 = T1 + T2
where g1 and 92 are exogenous government expenditures in the two periods.

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