25.7 Suppose individuals face a probability of u that they will be unemployed next year. If they are unemployed they will receive unemployment benefits of

b, whereas if they are employed they receive w (1 — t) where Z is the tax used to finance unemployment benefits. Unemployment benefits are constrained by the government budget constraint ub = tw (1 — u).

a. Suppose the individual's utility function is given by u= {ry/s, where 1 — 5 is the degree of constant relative risk aversion. What would be the utilitymaximizing choices for b and t?

b. How would the utility maximizing choices for b and t respond to changes in the proba bility of unemployment, u ?

c. How would b and t change in response to changes in the risk aversion parameter 8 ?