As in problem 3, consider an economy where there are 10 identical consumers who con- template their optimal consumption plan for two periods. Assume now that the interest rate at which all consumers (and the government) can borrow and lend is zero. These consumers have income 60 in period 1 and income 40 in period 2.

(i) If the consumer would like to consume equal amounts in the two periods, how much does he need to save in period 1? How much will he end up consuming in both periods?

Assume that the government must spend a total of 200 in the rst period to repair a

damaged bridge, and that spending is nanced by a distortionary tax on all 10 consumers:

everyxdollars (per capita) raised cost consumersx+1x2dollars.10

(ii) Should the government run a decit? Why?

(iii) If the answer to (ii) is yes, how large exactly should the decit be?

(iv) Assume now that the spending must take place in period 2 instead of period 1. How

do his answers to parts (ii) and (iii) change?