In Hofstralia, initially nobody is defaulting on their loan, and the government is running a balanced budget in every period. Joe is a borrower. Draw Joe’s intertemporal budget constraint, use an indifference curve to show his optimal consumption bundle, and place an endowment point (and show its coordinates) on his budget constraint consistent with the fact that he is a borrower. Suppose that the government is eliminates taxes in the current period, and finances its spending through a deficit. Show graphically how the tax cut would affect Joe’s borrowing, and explain what would happen to his consumption and welfare. Would the Ricardian equivalence hold? Why or why not? Suppose now that due to a recession people start losing their jobs. Banks expect some borrowers to default but because of asymmetric information, they do not know which ones. Explain how interest rate on loans would change and why. Show on the graph and explain how events in the financial market would affect Joe’s consumption, borrowing and welfare. Suppose that again the government is considering financing its current spending through a deficit instead of taxes. Show graphically and explain how such a move would affect Joe’s consumption and welfare under these conditions Would the Ricardian Equivalence hold in this case? Why or why no

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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In Hofstralia, initially nobody is defaulting on their loan, and the government is running a balanced budget in every period. Joe is a borrower.

Draw Joe’s intertemporal budget constraint, use an indifference curve to show his optimal consumption bundle, and place an endowment point (and show its coordinates) on his budget constraint consistent with the fact that he is a borrower.
Suppose that the government is eliminates taxes in the current period, and finances its spending through a deficit. Show graphically how the tax cut would affect Joe’s borrowing, and explain what would happen to his consumption and welfare.
Would the Ricardian equivalence hold? Why or why not?
Suppose now that due to a recession people start losing their jobs. Banks expect some borrowers to default but because of asymmetric information, they do not know which ones. Explain how interest rate on loans would change and why.
Show on the graph and explain how events in the financial market would affect Joe’s consumption, borrowing and welfare.
Suppose that again the government is considering financing its current spending through a deficit instead of taxes. Show graphically and explain how such a move would affect Joe’s consumption and welfare under these conditions
Would the Ricardian Equivalence hold in this case? Why or why not?

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