There is a consumer who lives for two periods. Her income is given by Y1 and Y2. She has access to the credit market with the interest rate r. The government collects lump-sum taxes T1 >0 and T2 >0. The government can run a surplus or a deficit, but must borrow (or save) in the credit market at the interest rate r, same as the consumer. 1. Write down the government intertemporal budget constraint. Note that the government also has the access
There is a consumer who lives for two periods. Her income is given by Y1 and Y2. She has access to the credit market
with the interest rate r. The government collects lump-sum taxes T1 >0 and T2 >0. The government can run a
surplus or a deficit, but must borrow (or save) in the credit market at the interest rate r, same as the consumer.
1. Write down the government intertemporal budget constraint. Note that the government also has the access
to the credit market. Write down the consumer’s budget constraint. Show the consumption choice
graphically.
2. Imagine that the government decreases the taxes in period 1 and raises tax in period 2 to pay back any debt
and interest from the previous period. This is anticipated by consumers. Show the new consumption choice.
How does that compare to the result from the previous section.
3. Assume that the government is not constraint by the balanced budget and can have deficit in both periods.
Now the government is being generous and pays transfers T1 < 0 and T2 <0. Show the new consumption
choice.
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