8.5 Credit constraints and Ricardian equivalence Consider the following variant of question 1. The household solves max a (Cl) + 61.5(02) cl,a,02 at. a = 311 T1 C1 :2 =y2T2+(1+T)a a 2 b (8.5.1) (a) What does equation (8.5.1) mean? What does 5 represent? (b) Plot the household's intertemporal budget constraint. In the same graph, plot constraint (8.5.1). (0) Solve for cl, (2'2 and a in closed form. [Hint notice that the constraint (8.5.1) is a weak inequality, not an equality, so it may or may not be binding. If it is not binding, then you can use the answer from 1. Then think about What happens if it is indeed binding. Then gure out Whether or not it will be binding] (d) Show that, other things being equal, constraint (8.5.1) is more likely to be binding if i. 3/2 T2 is high ii. yl T1 is low iii. 5 is low 8.1 Two period problem with taxes and initial wealth Suppose a household solves the following twoperiod consumptionsavings problem with taxes, which we will call Problem A: max @5021) + 315(02) C1 ,a,02 5.15. G=a0+y1T1Ci Cg=y2T2+(1+T)a Clio with u (c) = 1_a , where: 0 C1 is consumption at time 1 o Cg is consumption at time 2 I yl is household income at time 1 0 3/2 is household income at time 2 0 T1 are taxes at time 1 o T2 are taxes at time 2 0 a0 is initial wealth