Answered: Consider the two-period…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

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

a) Explain what is meant by a representative household. Briefly explain the budget constraints of the representative households and of the government. Explain the role played by the assumption that the representative households lives for only two periods and the assumption of “no discounting”.

max{log c1 +1log 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 a, 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 gi and 92 are exogenous government expenditures in the two periods.

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