budget constraints

1. (20 points) An employee has to choose between two contracts. Under contract A, she has gross incomes y and y' in the current and future periods, respectively, and has to pay taxes t and t' in the current and future periods, respectively. Under contract B, an employer offers the employee the option of shifting :1: units of income in the current year to the next year. That is, the option is to reduce income in the current year by 3: units and increase income in the next year by :1: units. Taxes are the same under both contracts. Assume that the net real interest rate on saving and borrowing equals r > 0. (a) (10 points) Write down current and future budget constraints and the lifetime budget constraint under the two contracts. Which contract would the employee choose? (Hint: you should compare lifetime wealth under the two contracts.) (b) (10 points) Assume that preferences over current and future consumption are U (c,c' ) = ln(c) + ,8 ln(c'), where B = 113. Find consumption in the current and future periods and saving under the two contracts. Compare consumption levels and saving under the two contracts