Assume that consumers are free to decide how many hours to work. Consumers have the following utility:

U = U(c1, l1, c2, l2)

where c1, c2, l1, and l2 are consumption and leisure in the first and second period respectively. Consumers earn a wage w1, profits 1 and pay lump sum taxes T1 in the first period and w2, 2 and T2 respectively in the second period. They have a total h hours at their disposal for work and, and can buy or sell any amount of bonds at the same interest rate r.

(ii) Due to a financial crisis that created a lot of uncertainty, bonds have a risk premium x. How does this affect the borrowing and lending interest rate? Show in a graph how does this affect labor supply. Explain the intuition