Consider the aggregate version of the two-period endowment economy, the two-period model of consumption.

a) Write down the current aggregate output demand and the aggregate output supply. Discuss the signs of consumption demand to changes in current income (Y), future income (Y), current and future taxes (T, T'), and the real interest rate (r).

For the next sections assume we begin in equilibrium and illustrate using the graph for the relevant market the impact of the following shock. Provide a brief description of the economic forces at work. Notice that the government needs to meet its lifetime budget constraint.

b) An increase in G financed through an increase in T.

c) An increase in G leaving T and T' unchanged and therefore compensated by a decrease in G'. d) Briefly discuss the differences on the response of the interest rate in a) and b).

e) Imagine that for a given path of government expenditure the government decides to reduce current taxes in order to stimulate current consumption. Will the tax cut achieve its goal? Why or why not? Discuss some of the reasons for the failure of Ricardian Equivalence in real economies.