In 2015 Colombia experiences a temporary reduction in economic activity due to the drop in energy prices.

a) Illustrate the effects of a temporary drop in current income on the Colombian saving and investment graph, assuming that Colombia is a small, open economy that before the drop in current income was running a CA deficit.

b) How does the age structure of the Colombian population affect the extent of the change in the CA balance? Explain by referring to the share of the different age groups (those in their first and second periods of their life).

The Colombian Government responds to the drop in energy prices by increasing lump-sum taxes. We will analyze the effects of the increase in taxes holding current income constant. Assume that the total tax revenue, T, from the lump-sum taxes is paid by Colombia's two representative agents: Hector, who is currently young and in his period 1, pays ; Alejandra, who is currently old and in her period 2, pays . As a result, the government total tax revenue is = +

.

c) What would be the effect on the increase in taxes on Alejandra's consumption and private saving, assuming that she does not care about the welfare of the young?

d) Illustrate Hector's problem on an intertemporal budget constraint before and after the change in taxes, assuming that he anticipates that the higher taxes in the present will reduce taxes in the future and that he will be the sole beneficiary of the lower future taxes. Make sure you show Hector's oldand new endowment points, assuming that he has no wealth. (Hint: note the difference between and and )

e) What would be the effect on the increase in taxes on Hector's consumption and private saving? Explain.